If you’re looking for proven ways to beat inflation and generate wealth, real estate is likely your best bet. According to the Federal Reserve Bank of San Francisco, real estate investing offers many advantages over other investments — including stocks. Over time, the Fed says, real estate values appreciate more, and real estate investments enjoy unique tax advantages. Rental real estate is an inflation hedge because rents tend to increase with the overall cost of living.
However, buying property and holding it, flipping it, or renting it isn’t for everyone. The upfront investment is high, and the time commitment can be burdensome. In addition, real estate investment can be risky if you’re inexperienced.
Fortunately, passive real estate investments require much less money, time, and expertise. If you want to add property investments to your portfolio, consider these five strategies for passive real estate income to create the ultimate side hustle.
Real Estate Investment Trusts (REITs)
REITs (pronounced “reets”) use investors’ money to buy and operate income-generating properties for long-term cash flow. These properties can include apartment complexes, shopping malls, office buildings, or hospitals. You can purchase shares in REITs for as little as $500. As long as they pay out at least 90% of their taxable profits to investors, REITs are exempt from corporate income tax. This leaves more money for you and can make them suitable for including in an IRA or other tax-advantaged retirement account.
REIT shares are generally considered a safe investment for long-term passive income. However, if you need to get out sooner, you can sell them quickly and easily.
There are three main types of REITs.
- Equity REIT: Equity REITs buy, own, and manage real estate properties that generate rental income.
- Mortgage REIT: Mortgage REITs purchase mortgages or mortgage-backed securities. Their main source of income is mortgage interest.
- Hybrid REIT: Hybrid REITs invest in both mortgages and rental properties and generate income from both rents and mortgage interest.
REITs can be publicly traded and regulated by the Securities and Exchange Commission (SEC), non-publicly traded (registered with the SEC but not traded on national exchanges), or privately traded among a group of selected investors. Publicly traded REITs are subject to the most oversight, but non-publicly traded REITs may be more stable because they are less liquid. Privately traded REITs have fewer consumer protections.
Online Real Estate Investing Platforms (Crowdfunding)
Real estate crowdfunding refers to a group of investors who combine their resources to buy real estate for investment. You can find crowdfunding opportunities through online platforms such as Fundrise, which connect investors who are looking to finance projects with real estate developers.
Once you find an investment that meets your requirements, you commit your money. And when the project secures enough commitments, money changes hands, and the investment is closed. The developer operates the project and generates passive income for you and the other investors.
Real estate investing platforms are similar to REITs in that you can get in with a relatively small investment. Crowdfunded projects typically have lower maintenance costs and regulatory expenses than REITs, leaving more profits on the table for investors. Crowdfunded real estate investments can generate higher returns — 15% is not uncommon.
The downside of crowdfunding, however, is that it’s less regulated and riskier than a REIT. It’s also a lot harder to sell shares if you need to cash out early. You’ll have a hard time finding crowdfunding projects if you’re not an SEC-defined “accredited investor” with a high income or high net worth.
There are some projects available to non-accredited investors. They come with more protection and less risk.
Real Estate Funds
Real estate funds are mutual funds or ETFs (exchange-traded funds) that mainly focus on real estate. Many real estate funds invest in REITs, so they can be great for diversifying among many types of real estate.
Many real estate funds invest in commercial properties such as apartment complexes, office buildings, retail establishments, and land. Real estate funds require minimal investment and are extremely liquid.
One advantage that real estate funds have over REITs is that they are not required to pay out most of their income. That leaves them more money for reinvestment in additional properties. They also allow you to diversify more than REITs do because one fund might invest in many different types of REITs.
Fully Managed Rentals
If you don’t mind spending more capital but don’t want to actively manage income property, consider buying your rental and then turning it over to a property management company. The cost of property management depends on the area, desired services, and whether you target a long-term or vacation rental market.
There are some advantages to owning tangible property. You have more control because a fund manager isn’t making all of the decisions. Owning real property instead of shares in a fund allows you to take advantage of strategies like 1031 tax-deferred exchanges. It can be complicated (the 1031 rules in Arizona differ quite a bit from those in California, for instance), so it does take more time on your part.
Property managers find quality tenants, keep the property maintained and in good repair, collect rents and perform evictions when necessary. Understand that even if you hire a property manager, your investment isn’t exactly on autopilot. You’ll still have to determine when to repair or replace systems and what kind of tenants you want.
You’ll also have to take charge when it’s time to resell your properties. You can establish a relationship with a traditional real estate brokerage (check out agent review sites like MyAgentFinder) or try selling property yourself on a free platform such as Zillow.
Partnering With an Active Investor
There is an alternative to finding your own properties if you’re inexperienced. You could partner with a knowledgeable, hands-on investor who will take the active role. You provide the money while your partner contributes the know-how and the time. You split the income and profits according to a written agreement.
In some ways, this arrangement is the best of all worlds — you get to agree on the specific property for investment without having to perform any analysis or day-to-day management. Understand, however, that you’ll have very few consumer protections with this arrangement, and you may have very little control over what your partner does. Being the silent partner can be very lucrative, but your investment is only as good as your active partner.
Comparing Passive Real Estate Investment Strategies
The chart illustrates the tradeoffs of passive real estate investments. Before investing, determine the amount of capital and time you want to commit as well as your risk tolerance.
Real estate investing can be profitable and challenging. If you’re just starting out or don’t want to spend too much time managing your investment, passive strategies are a great option.