We have been advised since our childhood to study hard and develop our skills to secure a job and make money. Hard work is very important and putting in the extra hours in the office can surely help to increase our earnings. Most people slog their days to earn their bread and butter. But what if there was a way to earn money through smart work? What most people miss is generating streams of passive income which can grow on their own without any need of pouring our time and efforts every day. Though actively earned income is satisfying, building passive streams of income is equally important to attain financial freedom in our life.
Our ancestors have been betting on real estate as one of their greatest assets. But little attention has been given to earn passive income from it. No doubt rental yields have been a great source of passive income, but modern-day technology has put forth a couple of more options that are better in generating passive streams of income. In this article, we focus on understanding what active and passive income means in real estate investing, and which modern-day real estate assets can generate passive as well as active income for you.
Active Income in Real Estate
Earning active income in real estate demands a lot of effort from the investor. The investor needs to select and purchase the right property having the necessary amenities and perfect location. Furthermore, the property must be upgraded in terms of interior and exterior to suit the requirements of the tenants. Managing the tenants as well as the maintenance of the property requires constant work from the investor or the landlord of the property. Thus, properties owned by the investor and generating rental cash flows are termed as active income from real estate. One thing to note here is though residential rental income is usually passive, renting out a property as a business requires far more attention and work regularly and thus makes it active.
Types of Active Real Estate Investments
- Vacation Rentals
Leasing out a property as a vacation stay acts as an active real estate investment. Listing your property on vacation rental sites like Airbnb or VRBO can earn you massive profits if the location is touristy. For this, the landlord needs to make arrangements for clean furnishings, the ambience of the room, installation of necessary furniture and appliances, and take care of daily maintenance. Thus, investors need to put in efforts daily to earn income out of such properties.
- Property Flipping
Property flipping means renovating an investment property and selling it to the final consumer at a higher price. Thus, the investor needs to carefully find the property having the potential to list at a higher price after fixing it by renovation. It is a tedious task and requires a great contribution of time, money, and effort.
Now that we have understood active income in-depth, let’s further understand what passive income in real estate investing entails.
Passive Income in Real Estate
Passive Income refers to earning income without any active contribution or effort from the investor. The traditional way of earning passive income in real estate is to lease out for the long term. In real estate, passive income can also be earned without actually owning a real estate property. The investor needs to just put in his money in real estate assets and the effect of price appreciation or investment management companies can grow the investment and generate passive income from it. This saves time and effort for the investors and they can earn money even while they enjoy a vacation. Passive Real Estate Investing is a smarter way of earning returns without much contribution of time and effort.
Types of Passive Real Estate Investments
- Long term Rental Yield
Traditionally, real estate investors have been earning consistent passive income through long-term rental agreements. This type of passive real estate investment requires an initial effort of time and money to purchase a property having sustainable location advantage and which can provide basic requirements of the tenants. Once the property is purchased and renovated, long-term lease agreements of usually 11 months or more, are signed with the tenants. Thus, a secured stream of cash flow is generated.
- Real Estate Crowdfunding
Real Estate Crowdfunding is financing a real estate project by investing through a crowdfunding platform. The crowdfunding platform pools in all the funds from a larger investor base and invests the same for financing bulky real estate projects. The funds invested are rewarded with a fixed percentage of interest at regular intervals. Moreover, the investor doesn’t get ownership of the property. Thus, the hassles of maintaining the property are also eliminated. Investing in real estate crowdfunding is a great source of earning passive interest income over 8 to 10 years.
A Real Estate Investment Trust is a company that owns, manages, and sometimes finances large ticket-sized real estate projects. Investing in such REITs through Mutual Funds or direct stocks can reap substantial returns over a long period. Recently, Indian financial markets witnessed the listing of three REITs over last year which received immense popularity among the investors. Investors get a chance to earn 90% dividends from the profits made by these companies. Thus, a more sustainable cash flow can be generated over a long period.
Active Vs Passive Real Estate Face-off
|Comparison Points||Active Income in Real Estate||Passive Income in Real Estate|
|Ownership||Ownership of the property is with the investor||Ownership of the property may or may not be with the investor|
|Maintenance of the property||Complete maintenance is borne by the landlord||In terms of long-term rentals, maintenance is borne by landlords. For other options, the investor doesn’t bear the property maintenance.|
|Control||Investors have full control over their investments||Investors have little to no control over their investments.|
|Initial Investment||High Initial Investment required.||Smaller investments can also be viable for Real estate crowdfunding and REITs|
|Risk Management||Investors can manage risk by careful due diligence of the investment||Investors cannot manage risk to some extent by diversifying their portfolio.|
As we dived deeper into the basics and types of active and passive investments, choosing between the both can be a task for the investors. Though both types of investments have a great advantage in their way, investors need to choose between the two only after introspecting their investment preferences. For that, here are the three factors that investors need to ponder on to decide which active or passive real estate investment is best for them.
- Time Dedication
If the investor doesn’t have enough time to dedicate to the maintenance of real estate investments, then passive investing is the best option for them. And if investors have real estate as the preferred option for earning their bread and butter, then active investing is more suitable for them.
Active real estate investments require a certain level of expertise to carry out all the due diligence and legal formalities correctly. If an investor doesn’t hold the expertise in real estate, then passive real estate investment options will be best suitable for them.
- Control over the investment
In passive real estate investing, the investor doesn’t have much control over choosing the kinds of property to invest in. Thus, if the investor wants to be in full control of his/her investment, active investing is the right type.
With the above key factors to keep in mind, the investor can make a better decision in terms of choosing active or passive real estate investment. Along with that, proper due diligence is essential before entering into any type of real estate investment. To readily taste the benefits of real estate, passive income investing is a premier option for investors.
For investing in smart real estate investments, Assetmonk provides innovative options ranging from Growth, Growth Plus, and Yield Models with an expected IRR of 21 percent per annum. To get started, visit our website today and unleash your financial freedom.
Active Income vs Passive Income in Real Estate FAQ’s:
Active Income is earned by putting indirect efforts in terms of time and expertise. Some examples of it are salaried income, business profits, and so on.
Passive Income refers to earning income without any active contribution of effort from the person. Such income can be earned with an initial contribution of time or money which generates a stream of cash flows for a relatively long term.
What are examples of passive income?
Some examples of passive income are real estate lease rents, dividends from shares, interest income, and so on.
What is the difference between ordinary income and passive income?
Ordinary income is termed as income earned from working such as wages, salaries, business profits, or even short-term gains from the sale of assets. As against this, passive income is the generation of cash flows from an investment in the form of rent, dividends, interests, and so on.