When people talk about fiscal responsibility, they often focus on cutting your spending and managing your debt. But what about increasing your income?
But there are other ways to earn money besides working a second job. And one of those ways is by creating a stream of passive income to supplement your normal wages. If you do it right, a passive income stream can be a lot more sustainable than trying to juggle two or three jobs for years on end.
One of the most common kinds of passive income streams is owning a rental property. Sure, being a landlord isn’t going to work for everyone, but if you have an extra room in your house or can get the financing to buy a second property, this could be a great way to create a steady and stable source of extra cash. So is being landlord worth it?
What is Passive Income?
When you go to your job, you put in a hard day’s work and then collect a paycheck. Would you say that you earned that income by being passive? Of course not! You worked hard for that money! (So hard for that money!)
That’s why income you’ve earned from a job is considered “active” income. You were paid money because you went out and worked for it. If you just didn’t show up to your job one day, your boss wouldn’t pay you, would she?
Passive income is different. With a passive income, you own something that earns you money even when you aren’t doing anything. This doesn’t mean that there isn’t any work involved with a passive income (life isn’t that easy) but it involves much less work than an active income does.
Investing money is a great example of passive income. You put money into, say, a 401(k) investment account, and over time the account earns interest. By the time you’re ready for your retirement, you have much more money in the account than what you originally put into it.
To rent or not to rent
When it comes to creating passive income through owning a rental property, there are obviously going to be some upfront costs. For instance: buying a rental property. This might disqualify some folks with bad credit, but not as many as you might think.
With secured loans like a mortgage—which is backed by the very real estate you are purchasing—there is a lot more security for the lender than there would be with an unsecured personal loan. Now, a low credit score would mean higher interest rates on your loan, so you’ll want to be extra careful when evaluating whether owning a rental property makes sense.
Here’s where handyman skills can come in, well, handy. Buying a lower-end or foreclosed property and then fixing it up yourself could lead to a sizable increase in the property’s value. All of a sudden, the rent you’re able to charge is well above what you’re paying on your mortgage.
If there are a lot of empty houses in your neighborhood, you might be able to get one of them for a song. And if you live near a local college or university, renting out to students is always an option.
Again, owning a rental property—or even renting out a spare room—isn’t going to work for everyone. But if you’re up for it, you should definitely do the legwork to see if it’s possible.
The perks (and perils) of being a landlord
Even though owning rental property can be classified as a “passive” income stream, that doesn’t mean that it isn’t going to require some work. For instance, the state of the property might lead to your investment being a little more “active” than you would like. If your tenant’s water stops working or their boiler goes on the fritz, you’ll be the one responsible for getting it fixed.
But if maintaining the rental property is something you’ll be able to manage, that property could give you a very stable and consistent source of income.
“There are very few assets in the world that offer principal protection, inflation protection and cash flow other than real estate,” says Aaron Norris, a California-based real estate investor and vice president of the The Norris Group.
“I go into owning rentals strictly on conservative cash flows. I want to invest knowing if the market fluctuates, I don’t care because the cash flow from rents easily covers costs and debt if I decide to get financing. Making things too tight will almost guarantee you’ll lose money.”
One of the great benefits of rental properties is that they provide some protection against inflation. “If inflation occurs, you’ve got an asset packed with commodities (cement, wood, and other building materials) that take the ride with inflation,” says Norris.
“If prices increase, that’s even better. But, it doesn’t necessarily mean I’ll cash out. I’m in it for the long haul and I’m there for cash flow.”
There is, however, a major downside to being a landlord. If something in your rental property breaks, it’s up to you to fix it. If you’re the handy type, this might not be much of a problem; you can keep that ancient boiler running for years using nothing but duct tape and a harsh look.
But if you want your passive income stream to be a little more, well, passive, than it might be a good idea to hire a property manager. Sure, this will cut into your income stream, but the added costs might well be worth it.
“Sometimes people want the same cash flow and potential for equity gains but don’t like dealing with tenants” says Norris. “I do have property managers, especially in areas in different time zones or assets that come with special circumstances.”
He offers the following example:
“I own a condo where there’s a property manager that manages the vast majority of the other condos. She’s been a major asset in making sure repairs take place or if there are issues with surrounding tenants, she’s involved. I’ve delegated and it’s been awesome.”
What to know before becoming a landlord
If you’ve ever had a landlord that was a little too lax in how they handled your rental agreement and making repairs, then you know exactly how irritating that sort of attitude can be. Don’t be that landlord! It’s not only wrong, it could also be very very costly in the long run.
“Legions of Americans buy investment property every year based on popular adages like, ‘Property is wealth.’ Even President Donald Trump has said, ‘To me, I love real estate because you can feel it,’” says Elizabeth Gibson, Chief Content Officer for ezLandlordForms.com.
“But the passive income of investment property requires careful business planning, and either a completely maintenance-free property (rare) or a reliable property management firm. Too many would-be landlords find themselves under water without good planning.”
Gibson has some excellent advice for prospective landlords. Sticking to these principles, she says, is crucial for success:
- Thoroughly screen tenants: “Tenants legally hold possession of your property during the lease term. You have a right to perform a credit check, call previous landlords, and verify their income.”
- Treat tenants well: “They are your customers, and your landlord business can’t succeed without them. Sometimes it might make sense to forego—or minimize—a rent hike to keep an A+ tenant.”
- Write a solid lease: “It should meet federal, state, and local laws and should address common rental issues as well as specific issues pertinent to your rental.”
- Don’t delay if things turn sour: “Send lease violation notices immediately after a violation. Don’t accept unpaid rent. Don’t hesitate to send proper ‘pay or quit’ notices. Never count on a verbal agreement.”
Like we said up top, making money through a rental property isn’t going to work for everyone. And if you’re on the fence, it would be a good idea to start small.
Rent out your spare bedroom or turn that room above your garage into a living space. You could rent those out before trying to finance a full rental property. Sites like Airbnb and HomeAway also let you rent out extra rooms for short periods of time.
Not everyone’s meant to be a landlord, but for those who are it’s a great option to earn extra income and build additional wealth for the long-term.
Elizabeth Gibson (@ezLandlordForms) has captivated marketing and news audiences with her award-winning writing. A former landlord, she now manages content for ezLandlordForms.com. The site’s two million-plus members range from novice landlords to veteran, multi-unit, property managers. “Landlords want to stay on top of property investment trends and manage their rentals efficiently; and, in spite of real concerns over eviction, as portrayed by Harvard sociologist Matthew Desmond, our members sincerely try to do well by their tenants.
Aaron Norris (@thenorrisgroup) is Vice President of The Norris Group, a California-based hard money lender specializing in flips, rentals, and new construction projects for real estate investors. You’ll catch him speaking at various real estate association conferences talking on technology (robotics, AI, IoT, and FinTech) and its effects on the future of housing and the real estate industry. Aaron is a Certified Specialist in Planned Giving (CSPG) and is passionate about philanthropy and giving back. You can find him on here on LinkedIn.
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