The Best Passive Real Estate Investment May Surprise You

By: , Contributor

Published on: Jan 21, 2020

Find the best way to invest in passive real estate for you.

Savvy real estate investors seek passive real estate investments, focusing on building cash flow and being able to replace regular income through real estate assets. But how do you know what the best passive real estate investment is?

We'll explain exactly what passive income investing is and then explore five different ways to earn residual income so you can determine the right avenue for you.

What is passive income investing?

Passive income investing is the practice of buying investments that produce residual income or cash flow without having to actively work on or in the investment. You as the investor are a passive, silent participant with the intention of earning a positive return monthly, quarterly, or at the end of the investment.

Passive investing, especially in real estate, isn't necessarily passive. You have to understand what you are investing in and dedicate time and effort conducting due diligence on the process of investing in that avenue of real estate, as well as researching and vetting the company, sponsor, or real estate deal. There is work involved in any type of real estate investing, even when the income earned is "passive."

The ultimate goal is to find an investment that, once funded, requires minimal time and effort to maintain while earning you a positive return and residual income on an ongoing basis.

Real estate investment trusts (REITs)

Investors can purchase shares of real estate investment trusts (REITs), which are companies that invest in and manage a portfolio of commercial properties earning a dividend return.

Real estate investment trusts (REITs) are a popular method of earning passive income because they require very little ongoing activity beyond the initial purchase and due diligence of the company. Since REITs are required to distribute 90% of their taxable income, dividend returns are higher than with other traditional stocks (often in the 3% to 12% range).

Shares can also be purchased for a few hundred dollars, making this a very accessible avenue for new investors or those with limited funds to invest. Since your investment is in shares, your money is rather liquid and shares can be sold at any time if needed.

Pros and Cons of REITs

Pros Cons
• They can provide competitive dividend returns (3% to 12% range, depending on the company).

• Investing in a company that owns real estate (and typically holds a diversified real estate portfolio).

• No active involvement after investing; the portfolio is managed by the REIT.

• Low upfront investment. Investors can buy shares for just a few hundred dollars.

• Available to anyone.

• Your investment is typically tied to the stock market, which fluctuates from time to time and may put you at risk of market swings.

Real estate crowdfunding

If you are an accredited investor, you can participate in a real estate crowdfunded investment, where several investors pool their money together to purchase a commercial real estate property that is managed by a third-party sponsor in exchange for a preferred return, equity split, or combination of the two.

Crowdfunding investments can be found on crowdfunding platforms, and investments can range from a few thousand dollars to hundreds of thousands of dollars. This avenue of earning passive income has grown rapidly in the past few years because of the high returns many investments offer, although it's not without risk.

Pros and Cons of Real Estate Crowdfunding

Pros Cons

• It can provide large returns (10% to 30% range, depending on the investment).

• You can access larger investment opportunities that you might not be able to buy or invest in on your own (like a large apartment building, hospital, or other commercial property).

• No active involvement after funding; the real estate investment is managed by a third-party sponsor.

• Only available to accredited investors.Long-term investment, where your funds are illiquid.

• Is considered risky, as the success of the investment and return is up to the sponsor and varies for each investment.

Rental property

Rental real estate is one of the most common ways investors choose to earn residual income, even though it's also one of the least passive methods of earning cash flow. Rental real estate provides owners with tax benefits, potential property appreciation, and the opportunity for passive income, but being a landlord can be a time-intensive commitment, depending on how the property is managed.

Many rental property owners choose to hire a third-party property management company to manage their rentals for them. Doing so relieves a lot of the active management involved with rental real estate, like showing units, collecting rent, and handling maintenance requests, repairs, or evictions or advertising vacancies.

However, there is still liability and risk in owning a rental. If vacancies go longer than expected or unexpected repairs pop up, an entire year's cash flow could be diminished. It also isn't a very liquid investment. Investors who want to leverage the property's equity will find it takes a few weeks to a few months.

Pros and Cons of Rental Property

Pros Cons
• It's possible to earn passive income, particularly if the property is managed by a property management company.

• It can provide competitive returns (8% to 20% range, depending on the investment).

• Potential to gain tax benefits and appreciation in addition to passive income.

• Available to anyone.

• Liability.

• Income isn't always passive -- especially if it's self-managed.

• Unexpected expenses or long vacancies can diminish cash flow.

• Long-term investment, where your funds are illiquid.

• Higher upfront investment, around 10% to 20% of the property purchase price.

Private lending

Private lending is another option for earning passive income in real estate in which the investor holds financing for a homebuyer or other investor. There is hard money lending, which is often used for fix-and-flip investors, or private loans, which are done among individual investors or friends and family.

Interest earned through private lending is often much higher than with a traditional mortgage, around 10% to 15%, and possibly with points, which is a percentage of the entire loan amount (like 1%). There is no active management involved since the homebuyer or investor is responsible for managing the property and investment, making it a great option for a retirement account.

Income earned from private lending is truly passive, as long as the borrower continues to pay. However, if the borrower fails to follow through with the agreement, the lender may need to pursue legal action like foreclosure, which can be costly and lengthy.

Pros and Cons of Private Lending

Pros Cons
• Truly passive as long as the borrower continues to pay.

•It can provide competitive returns (10% to 20% range, depending on the investment).

• Low upfront investment.

• Investors can buy shares for just a few hundred dollars.

• Available to anyone.

• May have to foreclose if the borrower stops paying, which can be costly and lengthy.Long-term investment, where your funds are illiquid.

• Higher upfront investment -- normally tens to hundreds of thousands of dollars.

Tax liens

Governments from time to time auction delinquent property taxes, issuing a lien against the homeowner until the outstanding taxes are paid. Investors can purchase these tax liens at public auction, reserving the right to be repaid the delinquent taxes in addition to interest and fees. Every state has a different interest rate that can be charged, sometimes up to 18%. But since auctions are competitive by nature, the returns received are often far less.

Tax liens can be purchased for as little as a few hundred dollars to as much as a few thousand, depending on the property and state, making it a good option for those who have limited funds to invest.

There is very little investor participation or management after the tax lien is purchased, making this a very hands-off, passive way to earn money, although there is significant work in researching which tax liens to purchase as well as how to participate in the auction.

Pros and Cons of Tax Liens

Pros Cons
• Truly passive after acquiring the tax lien.

• It can provide competitive returns (4% to 18% range, depending on the jurisdiction and winning bid amount).

• Not a passive upfront investment, requiring active participation during due diligence and auction participation. 

• Funds are illiquid while the lien is in place.

The best passive investment in real estate

Considering that there are numerous avenues to earn passive income in real estate, the best passive real estate investment is the one that is right for you.

Investing is very personal. What one person says is the best may not be the best for you. If someone says real estate crowdfunding is the best passive real estate investment, but you're unable to participate because you're not an accredited investor -- it's not the best for you.

My advice? Find the best investment for you based on your skill set, experience, available funds, and time available to conduct due diligence and invest.

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