Whatever method you use to earn money, your earnings will fall into two groups: passive income or active income. Furthermore, while you may have heard these two terms before, many people aren’t sure what they mean. Therefore, before we go further in this article, let’s solve the two obvious questions: what is the difference between passive and active income, and how to define passive income?
In addition, we’ll help you discover the world of passive income and how to excel at it through a wide range of real estate strategies.
Passive Income vs Active Income: The Difference
What Is Active Income?
Having a full or part-time job and earning a wage, commissions, or bonuses is an example of active income. In addition, active income includes earnings through self-employment or materially engaging in a business and being compensated.
Active income must be obtained before passive income can be generated for most individuals.
Real estate investors frequently perform a full-time job to make active income, then reinvest as much as they can to begin accumulating passive income streams from rental properties.
Passive Income vs Active Income: Examples of Active Income
Hourly earnings, either from part-time or full-time work, are a frequent source of active income. One of the potential benefits of getting paid by the hour is that an individual may earn additional money by working extra hours, weekends, and holidays.
Compensation is a set amount of money paid for working a set schedule, such as Monday through Friday from 8 a.m. to 5 p.m. Workers who are paid a salary effectively trade 40 hours per week for a predictable quantity of active revenue.
Commissions are another source of active income, although this varies greatly depending on the job. Real estate agents, for example, often receive a fee ranging from 3% to 6% when selling a home and a leasing fee equal to one month’s rent when leasing a property. People who work a straight commission job, on the other hand, frequently see their revenue streams fluctuate based on the time of year and the sales that are completed.
Tips are a form of active money earned due to the quality of service delivered. For example, people who work in the food service and hospitality sectors frequently earn a fixed salary or hourly compensation and tips from satisfied clients.
Additional sources of active income include freelancing and consulting fees. Individuals with in-demand skill sets, such as visual artists or software engineers, frequently create a freelance firm and work as independent contractors for customers.
What Is Passive Income?
Passive Income Definition
Earnings from a rental property, limited partnership, or other business in which a person is not actively participating are passive income. Passive income, like active income, usually is taxable, but the IRS treats it differently.
Passive Income Meaning
Passive income is generated by an income-generating asset in which the investor is not actively engaged. Savings from active income sources, such as wages, salaries, or other payments, were frequently used to purchase that item.
Investors do not have to pay Social Security or Medicare taxes on passive income. In addition, they can minimize their revenue tax obligation using a variety of potential tax deductions, in addition to not spending hours a day earning passive income.
Passive Income vs Active Income: Examples of Passive Income
Have you wondered how to build passive income? Passive income can be earned in various ways, such as by putting money into a certificate of deposit or by holding a bond.
Unfortunately, numerous investments pay an interest rate lower than the inflation rate. That means that investing in a property that delivers passive interest income can result in a loss of principal.
Among additional sources of passive income are dividends from publicly listed equities. Apple, Nike, and Mastercard are just a few well-known blue-chip firms that pay dividends.
Becoming a silent partner in a company or real estate venture with limited partnership revenues can be a more beneficial approach to earn passive income with greater potential returns from consistent income and a percentage of the profits if and when the company is transferred.
Rental real estate passive income can typically provide good risk-adjusted returns by producing periodic net income and the possibility of profit from property value appreciation when the residence is sold.
According to the Federal Reserve, the average sale price of houses sold in the United States has climbed by approximately 67% during the last downturn in 2007–2009. In addition, rents for single-family homes have also been rising.
Real Estate Investment Strategy: How to Generate Income
Real estate can provide active or passive income or a mixture of the two. The sort of income generated by real estate is determined by the investor’s strategy and whether the goal is to create future revenue in the short or long term.
Real Estate Income That Is Active
Investors who engage in real estate flipping and house wholesaling expect to profit from the property in a short period.
Home flippers buy a property for a lower price than the market, make any necessary improvements, and then resell the house to return to a buy-and-hold rental property investor or a purchaser seeking the main home. Flippers make fast repairs and then resell before the economic conditions alter.
Wholesalers specialize in spotting discounted properties, putting them under contract, and then assigning the purchase agreement to an investor for a minimal fee. Partnering with a real estate wholesaler can help you uncover off-market purchases with immediate equity once the escrow closes and the necessary repairs are completed.
Active real estate income generation typically entails a high degree of risk in return for a promise of a large payout. It can be comparable to performing a full-time job. Active revenue from real estate falls if the property is no longer flipped or wholesale prospects are no longer available.
Now that this part is covered let’s move to real estate passive income details and how to get passive income in the first place.
Real Estate Passive Income: What You Need to Know
Buy-and-hold investors get passive income from real estate in two ways: ongoing net income once tenant rents are collected and bills are paid, and the potential gain from appreciation obtained when a property is sold.
Most real estate investors refer to passive income as “earning money while you sleep.” “Property owners continue to profit in their sleep without working, risking, or economizing,” political economist John Stuart Mill said.
To be honest, even when the day-to-day tasks of maintaining a rental property are assigned to a local land manager, earning passive income from real estate requires effort.
A passive real estate investor, for instance, checks financial records such as passive income generation and cash flow reports monthly, visits out-of-state properties regularly, and looks for new ways to scale up and increase a rental property portfolio.
One of the best aspects of having passive income investing is that it allows an investor to devote as little and as much time to their business as they like. In contrast, active real estate investors stop getting compensated when they quit working.
That is why many real estate investors are looking for ways to create passive income from their investments.
Passive Income Strategies: Real Estate
Passive real estate investors delegate most investment strategies to a fund manager or general partner of a personal equity investment. Every year, these experts see hundreds of investment options and can pick the ones that offer the best potential return while minimizing risk.
Long-term rental properties and REITs are two passive income ideas.
Buying Rental Properties as Long-Term Investment
The best way to make passive income from real estate investing is a long-term rental property. Long-term tenants in residential property often undertake a 12-month lease, whereas commercial tenants frequently sign 5-year, 10-year, or more extended rental contracts.
Tenants frequently renew their leases since the residential rental property is in limited supply in most areas across the country. According to a recent study, the average tenant in the United States stays in a property for 27.5 months.
By buying rental property, long-term rental property investors spend less money on tenant-turn costs like advertising, leasing, and renovating the property when a tenant moves out.
Let’s see what some of the best places to buy long-term rental properties are.
5 Best Places to Buy Rental Properties for Long-Term Investment
Investing in long-term rental property makes sense and, if done correctly, can produce a high return on investment. The following are some of the greatest places in the US housing market to buy a long-term rental property. Mashvisor provides all rental information:
- La Quinta, California
- Median Property Price: $962,111
- Average Price per Square Foot: $378
- Days on Market: 96
- Traditional Rental Income: $4,645
- Traditional Cash on Cash Return: 4.34%
- Price to Rent Ratio: 17
- Walk Score: 22
- Rotonda West, Florida
- Median Property Price: $482,088
- Average Price per Square Foot: $244
- Days on Market: 25
- Traditional Rental Income: $3,414
- Traditional Cash on Cash Return: 6.10%
- Price to Rent Ratio: 12
- Walk Score: 4
- Eastover, North Carolina
- Median Property Price: $244,331
- Average Price per Square Foot: N/A
- Days on Market: 34
- Traditional Rental Income: $1,673
- Traditional Cash on Cash Return: 5.75%
- Price to Rent Ratio: 12
- Walk Score: 38
- California City, California
- Median Property Price: $290,354
- Average Price per Square Foot: $172
- Days on Market: 81
- Traditional Rental Income: $1,824
- Traditional Cash on Cash Return: 5.07%
- Price to Rent Ratio: 13
- Walk Score: 48
- Show Low, Arizona
- Median Property Price: $506,567
- Average Price per Square Foot: $277
- Days on Market: 33
- Traditional Rental Income: $2,328
- Traditional Cash on Cash Return: 3.52%
- Price to Rent Ratio: 18
- Walk Score: 50
It’s worth noting that the cap rates given above are the city’s average. Mashvisor’s Rental Property Finder can help you identify properties with a high cap rate. Click here to try it out for free.
Easy Passive Income: Self-Storage Facilities
Self-storage facilities are another way for building passive income, and they have similar features. The average length of time a self-storage unit is rented is 14 months, with over half of all clients renting for over a year. The self-storage sector produces annual gross sales of $39.5 billion from 13.5 million households or 10.6% of all households in the United States.
Self-storage investors can make passive income from higher returns than residential rental property owners. For example, the average national monthly cost per square foot for a self-storage facility is $0.91, comparable to renting an apartment in some locations.
A self-storage unit is also significantly less work demanding to own and operate. As a result, the average profitability of self-storage businesses is 41%, approximately double the average profit margin of all sectors, with a national average occupancy of around 92%.
Creating Passive Income: REITs
REITs (real estate investment trusts) are a simple way of investing in income-producing real estate. Most of those top REITs are traded publicly on the primary stock markets, including American Tower, Prologis, Public Storage, and Equity Residential.
Since REIT shares can be exchanged like any other stock or bond, they are extremely liquid. However, when it comes to passive income, several REITs specialize in certain real estate types, such as single-family rental property or self-storage.
Investing in a REIT has some potential risks as well. Dividends, for instance, are taxed as ordinary income and may be subject to numerous tiers of management and transaction fees. As a result, putting money into one or more REITs could be an excellent strategy to diversify an investment strategy.
10 Real Estate Smart Passive Income Ideas
The numerous advantages of passive income may have sparked your interest in learning how to generate passive earnings for yourself. You can go down many pathways that will lead to passive income streams. Take a look at the following ways to make passive income:
- Single-family units: Begin with the most basic example if you’re wondering how to make passive income in real estate. A single house or condo can be acquired and rented to a single renter, making it the most basic sort of property to comprehend.
- House hacking: When opposed to apartment complexes, properties with up to four units give similar advantages to single-family homes but require less management. These properties might be a little more challenging to manage than a single-family unit due to the greater number of renters, but they produce superior cash flow.
- Apartment buildings: This is a category among common passive income sources for properties with five or more units. Investors can benefit from economies of scale by taking out a business credit rather than a residential loan. However, they should be ready for more intense management or hire an expert property manager.
- Land lots: Investing in land can be unique, and it can be utilized to upgrade or split up into smaller portions for sale. This technique can generate passive income if the investor buys a piece of land in a developing area or one about to be developed and sells it for a profit.
- Vacation rentals: A property could be a potential short-term or vacation rental prospect, particularly in cities with a sizeable transitory population and tourism attraction. Vacation rental owners can often demand a higher per-night rate than they could with a long-term tenant, making this one of the best sources of passive income.
- Note investments: This is one of the best passive income opportunities, where rather than taking out a traditional loan, homebuyers might take out a private note loan. The purchasing and selling of such notes have a thriving industry. Investors can get a discount on both successful and non-successful notes by purchasing them from other owners.
- Property rehabs: Fixing and flipping houses demands a more active approach to real estate investing, but it can be very profitable. They can go through a rehab stage before getting rented properties located in a prospective rental market but are not up to standard in terms of looks and condition.
- Tax liens & deeds: When taxes are not paid, the government reserves the power to take a property. Tax lien properties can be purchased at a considerable discount for investors and be the best forms of passive income, but they should only do so if they have a good plan in mind.
- Industrial complexes: Although most people think about residential properties when they think of passive income, commercial assets should not be overlooked. For example, commercial warehouses, storage areas, and manufacturing plants can become a way of earning passive income with minimum supervision.
- Mixed-use developments: The need for mixed-use development projects has gradually increased, and they may accommodate tenants from various industries, including residential, office, retail, manufacturing, and academic. With these passive income business ideas, investors can benefit from a range of real estate income streams and lease terms.
Real Estate Investment Strategies: Question and Answers
Here are some of the most asked questions regarding passive income.
How to Generate Passive Income?
Purchasing a home and renting it out to tenants is a common way to generate passive income in real estate. In addition, maintaining rental properties can be a lucrative business venture. On the other hand, being a landowner is not a completely passive source of income and takes regular effort. Tenants will expect you to manage and update your home regularly. You should also devote time to investigating your property possibilities and marketing your area.
What Are the Best Passive Income Ideas?
Real estate ownership is one of the greatest methods of generating passive income. But it’s not as simple as purchasing a property or plot of land. For example, if you own a rental property, repairs and maintenance can be a considerable time and financial drain unless you have your property management on point.
What Are Best Passive Income Investments?
Rental income and REITs. You must decide three things to get passive revenue from rental properties: What kind of return you desire on your investment, the overall costs and expenses of the property, the financial dangers that come with buying a home. You can generate high passive income when you have your answers for those three things.
REITs are a way to go when it comes to passive income ideas with little money. Like every firm or dividend stock, REITs can be purchased on the stock market. You’ll get whatever compensation the REIT puts out, and the greatest REITs have a track history of increasing their payout yearly so that you might have a steady flow of dividends over time.
Conclusion
If you’re looking for a steady way to establish financial independence over time, passive income real estate may be the appropriate investment plan for you. However, if you’ve taken something away from this article, the term “passive” can be misleading.
Any investor should enter a deal determined to do their thorough research, ask the right questions, and provide the degree of dedication and involvement required to make that particular investment plan successful.
And when comparing active and passive income in real estate, it’s crucial to consider all of the aspects involved. There is no such thing as a single “ideal investment approach.” It is all up to you. Last but not least, keep in mind that there is no such thing as a completely passive investment. If you want to make money in real estate, you’ll have to put in some effort.
Finally, you should use an online tool specializing in assisting real estate investors in searching for an investment property. One of them is Mashvisor. You may search up to five cities in one go using our software, eliminating the need to open multiple tabs in your browser. In addition, you’ll be able to narrow down your results based on your criteria, such as market price, property type, and more.
To gain access to our real estate investment tools, click here and sign up for a 7-day free trial of Mashvisor today, followed by a lifetime discount of 15%.