Here’s how to use passive real estate investing in your portfolio.
Investing in real estate can be a smart move if you’re interested in creating new income streams. “Real estate can be a great way to generate passive income that’s not dependent on your principal employment,” says Rick Myers, founder and president of Integrated Financial Services in Grand Rapids, Michigan. As a landlord, you can reap the dual benefits of appreciation from your investment and ongoing rental income. That can help to ensure a more comfortable retirement or help to keep you afloat if an economic downturn results in the loss of your primary job. If you’re interested in using passive real estate investing strategies in your portfolio, here are seven rules to follow.
Pick your game plan.
Investing in real estate for passive income isn’t one-size-fits-all. Before wading in, first figure out what strategy fits best, says Colton Brausen, commercial broker for Kris Lindahl Real Estate in Minneapolis. For example, consider whether you’re more interested in owning an apartment building or multifamily home to generate real estate passive income versus a commercial building in which you’re dealing with business tenants. Also think about how involved you want to be when it comes to things like collecting rent or handling repairs, and whether you’d prefer to hand off those duties to a property management company. “There is no right answer,” Brausen says. “It depends on you as the investor and where your comfort lies.”
Passive doesn’t mean hands off.
Generating real estate income passively can help you make money in your sleep, but it requires putting in some work up front to get that income flowing. “Too many people are passive about the investment decisions themselves, and that can lead to very active headaches,” says Adam Kaufman, co-founder and chief operating officer of ArborCrowd, a real estate investment firm. While there are plenty of opportunities to create passive income, rental property investors can’t skip out on due diligence. Kaufman says investors should be proactive in thoroughly researching investment properties. That means asking questions about the property and the seller before committing to the purchase. And if the answers you get leave you with even more questions, you should probably move on, he says.
Diversification matters as much as location.
When using real estate for passive income, it’s important to consider the level of diversification in your portfolio. “Investing in a portfolio that’s diversified by property type, tenant mix and geography will greatly increase the probability that it will provide a stable and predictable stream of income over the long term,” says Scott Bennett, a real estate advisor with Wells Fargo Private Bank. Depending on how much you have available to invest in passive real estate, that may mean owning multiple rental properties. Or you could choose to spread your investment dollars across different real estate mutual funds, real estate investment trusts or crowdfunded rental properties. Diversifying real estate income streams is key to balancing risk and reward.
Pay attention to real estate market trends.
Certain segments of the real estate market may perform better than others during periods of market volatility or broader economic shifts, such as a recession. For instance, Jeff Holzmann, CEO of IIRR Management Services, points to the multifamily sector as potentially being more resilient than commercial properties such as hotels or office buildings during challenging economic environments. While multifamily housing isn’t completely risk-free, it may offer better opportunities for returns if demand for residential rental units remains high. Learning how various parts of the real estate market react to changing economic conditions can help you find the best opportunities to keep passive real estate income coming in consistently when the country is experiencing a downturn.
Choose the right capital sources.
When buying real estate for passive income, taking out a loan is an obvious choice — but don’t overlook the benefits of leveraging retirement assets to create rental income. “A self-directed IRA gives you the opportunity to make investment decisions in areas based on your knowledge and expertise,” says Kelli Click, president of Strata Trust. You can use a self-directed individual retirement account to purchase residential rental properties, commercial rentals or even land to generate passive income. Leveraging IRA assets can help you avoid taking on debt and having interest payments on a loan detract from your returns. There are certain IRS rules you need to follow when taking this route, so Click suggests bringing a third-party property manager on board to avoid overstepping.
Know your time horizon.
Passive real estate investing is something you could include in your portfolio for years to come, but it’s important to know your time horizon when deciding which properties to invest in. “High-quality real estate is more illiquid in nature and designed for the long term,” says Peter Brunton, chief investment officer at Strategic Wealth Partners. That means if you anticipate needing the cash you’re planning to invest in a rental property in the next five to 10 years, you’ll need to think ahead about how easy it will be to eventually offload that asset. Again, that goes back to performing due diligence and studying market trends so you have an idea of what demand for the property will be like down the line.
Professional help can make passive real estate investing easier.
Whether you’re investing in real estate for passive income for the first time or you have several years of experience owning rental properties, consider calling in the professionals for help. That starts with connecting with an experienced agent who can walk you through the pros and cons of various investment options, Brausen says. Once you find a rental property for passive income, your team may expand to include a property manager, real estate attorney and contractors to get the property in shape or keep it maintained. Some of your profits will go toward paying them, but it can be well worth it if you’re able to generate real estate income without doing any heavy lifting yourself.