What Is Passive Income And How Do You Generate It?

What Is Passive Income And How Do You Generate It?

Posted by on Nov 2, 2020

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Potential passive real estate income typically requires less effort and maintenance compared to direct real estate investments. Of course, you’ll want to stay on top of what’s going on with passive income sources and sponsors (if applicable). Designing a passive income plan isn’t a set-it-and-forget-it. But unlike earned income generated from a job (i.e., employee), passive income requires little  involvement once it is set up. 

Passive income leverages your time. Instead of trading your time for dollars as you do with a job, a passive income plan strives to generate money while you do something unrelated. For example, if you are selling digital widgets that cost $50 each and the entire payment and delivery processes are automated, you do not need to be present for each sale. The system is designed to continue generating money without your involvement.

A stream of passive income is one source of income generated from a passive system. There’s no reason to stop at one stream of income. You can create income diversification with multiple streams of passive income. If one stream of income fails or decreases, the others will continue generating income independently. Researchers have pointed out that the average millionaire has seven streams of income.

What does a stream of passive income look like?

Most Common Types Of Income

Earned Income – This is your day job, and most people’s primary source of income. You trade your time for money.

Business Income – You own a business. You either make and sell something or provide a service.

Interest Income – This is income made from lending your money out. This might mean a CD, P2P lending, real estate crowdfunding, funding fix-and-flip debt deals, or simply money in a savings account.

Dividend Income – This is money that’s distributed as a result of owning shares of a company.

Rental Income – You own something, and you rent it out. Probably the most common is owning a rental property, such as a multi-family apartment building (renting apartments in exchange for monthly payments).

Capital Gains – This is money earned when you sell an investment, like stocks.

Royalties / Licensing – You create a product, idea, or process, and you let someone use it. They pay you a small fee every time they do.

Real Estate Passive Income

Direct Property

Direct real estate investing is the purchase and management of an investment property. This can be as a single investor, with partners, or using debt financing. Management of the property doesn’t mean trading time for dollars. While managing the property will require time, the property generates rental income, which isn’t a 1:1 trade of time to money. Additionally, by hiring a contractor, employee(s), or even a property management company, the investor can outsource property management. 

However, for the above scenario to be considered passive income, the direct property owner would need to hire a turn key management company. Otherwise, direct real estate leans far more to the active income side.

DST

A Delaware Statutory Trust (DST) is a private real estate fund. The fund is managed by a sponsor, which means investors have no say in management decisions. A DST is truly passive real estate investing.

A DST invests in properties through the sponsor, handles any financing, and manages its properties all without any investor involvement. Investors must be accredited, and there is generally a multi-year holding period, as is the case with most real estate investments. DSTs may generate income for investors through cash flows, appreciation, or both.

A benefit of investing in a DST is that it can be used in a 1031 exchange. A 1031 exchange has specific rules and timelines about choosing a replacement property. By exchanging into a DST containing multiple properties, the investor may have more options when choosing a replacement property. Additionally, since there are more property choices, there isn't as much pressure to find a property within a specific timeframe, required by a 1031 exchange.

For investors who are tired of managing properties, DSTs provide an option for truly passive income potential. With some DSTs providing multiple properties, they also allow you to diversify your portfolio. 

REIT

A real estate investment trust (REIT) may be either a public or private security. Public REITs are very liquid and trade on public exchanges (similar to a stock). Private REITs lack liquidity and may require investors to be accredited. Like DSTs, REITs are also passive investments. REITs generate income through dividend payouts.

Real Estate Crowdfunding

Real estate crowdfunding has opened up passive real estate investing to more people. This is mainly because many real estate crowdfunding deals don’t require investors to be accredited and have very low minimums (some as low as $500). Investing in a crowdfunded deal is similar to investing in a private fund. It is entirely passive for the investor. The deal sponsor handles all investment decisions, and investors have no input into investment management.  Like DSTs, crowdfunded investments generate income for investors through cash flows, appreciation, or both.

Pursuing passive income allows people to leverage their time — they can generate income while doing something else with their time. There are many different types of real estate passive income opportunities available. The one you choose may depend if you are an accredited investor or not. The investment structure will determine how much control you have. Truly passive income deals require giving up decision-making control to someone else (i.e., the sponsor), which is why it's important to verify any sponsor’s track record, experience, and knowledge.

There is no guarantee that the investment objectives of any particular program will be achieved.

The actual amount and timing of distributions paid by programs is not guaranteed and may vary. There is no guarantee that investors will receive distributions or a return of their capital. These programs can give no assurance that it will be able to pay or maintain distributions, or that distributions will increase over time.

 


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