Passive Income Opportunities – Part 3 – Rental Income

Rental incomes have the advantage that the value of the associated asset and the incomes realized from them correlate well with inflation over the long term. This also explains why many consider it the safe haven in investment. A residential rental property, a strip of land, or an office space that is leased are eligible for this form of passive income opportunity. However, there are a few caveats -

Rental incomes can be considered truly passive only if the management of the asset is setup to be handled by a property management company.

• Delegating the entire associated maintenance tasks to a property management company attains the hands off approach in managing the rental property. Utilizing such a service has the obvious down side that the rental income is reduced by a sizable percentage as the property management company gets a considerable cut directly from the top line. There are several other expenses that get deducted from the rental income before passive income can be realized including -
• Expenses for the up-keep of the asset,
• Property taxes,
• Utilities.

It is not surprising therefore that in most cases the lion’s share is not what is left standing.

Leverage is mostly the norm and the associated risk needs to be weighed.

• Leverage is associated with a higher risk factor and has the potential to make you lose more than you invested on the asset. This is best understood with an example. You purchase a rental property for $100K with a down payment of 10%. Assuming you funded all the closing expenses which added up to 2.5%, your total investment in the property is $12.5K. To fund the purchase, the remaining $90K is realized by taking a mortgage on the property. At this point, you have an asset worth $100K for a net investment of $12.5K and your leverage is 90% (100 minus percentage you own). Assuming the property was later sold for $120K and the selling expenses added up to $5K, the return on your investment is $12.5K (115K – 90K – 12.5K = 12.5K or 100%). This sounds upbeat but the downside risk also needs to be evaluated. If the property was instead sold for $80K and the selling expenses added up to $5K, here is what ensues– you owe $90K to the mortgage company for which you have to come up with $15K. Or, you lost 15K more than what you invested – a loss of a whopping 217%. One way to mitigate this big risk is by planning to hold on to the asset for a very long time. Over the long-term, real estate prices, though cyclical, have always gone up. Thus the assurances for a positive return over the long-term are a shoo-in.

An often-overlooked item in the category for passive income is the house one lives in. As the single largest investment for most households, it is an important asset and so careful consideration need to be given as to how it is funded. In an abstract way, passive income can be realized if you own your home outright. Rhetorically, it has the effect of reducing your monthly expenses by a certain amount thus qualifying as another form of passive income. Property taxes and utility expenses are a damper to this income.



Related Posts:

1. Exiting the Rat Race - Definition.
2. Rat Race Exit Strategies. 
3. Passive Income - Part 1 - Network Marketing.
4. Passive Income - Part 2 - Royalties. 
5. Passive Income - Part 3 - Rental Income. 
6. Passive Income - Part 4 - Dividends.
7. Passive Income - Part 5 - Pension Plans. 
8. Passive Income - Part 6 - Employer Plans. 
9. Strategies to Beat Inflation.
10. Strategies to Reduce Expenses.
11. Frugal Living - A Definition to go by. 

Last Updated: 01/2015.