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As seasoned investors will tell you, the phrase “passive income” is largely an oxymoron—like the term “easy money” or, for Brit transplants like me, the sentence, “I think England can win the World Cup.” Amid soaring expenses, small investors are learning the hard way that passive income often equals massive headaches.
However, five years ago, it seemed like all investors had to do was lie back on a deck chair by the pool and watch the cash flood in. Post-COVID-19 pandemic, interest rates were around 3%, rents were soaring, and everyone wanted a piece of the residential real estate investment pie.
“The rents [we could charge compared] to the cost of buying it were insane,” William Lemmon, an investor in Akron, Ohio, told Realtor.com. “So we jumped in on it.”
At the time, in 2021, William and his brother Josh were buying homes for $60,000 and renting them out for $1,000 per month.
A Passive Income Phenomenon
As BiggerPockets investors know, that period was at the height of the real estate investing boom, when the BRRRR strategy for recycling money to buy multiple homes was in full swing. A Realtor.com analysis of Google Trends data found that search interest in “passive income with real estate” nearly quadrupled between 2019 and 2022.
Soaring rents, namely a 20% median increase for studios through two-bedroom apartments, from $1,451 in 2019 to $1,741 in 2023, according to Realtor.com data, coupled with historic low interest rates, saw small investors buy in bulk—scaling from 186,592 homes in 2015 to 363,434 in 2022—nearly double the 2015 total.
“A Job Right Out of the Gate”
However, many real estate investors discovered the hard way that “passive” income was rarely passive.
“They became a job right out of the gate,” William Lemmon told Realtor.com. “That was the start of what I told you—the expectations of how it was going to go passively—and then it did not go that way at all.”
Even in 2021, buying older homes meant heavy expenditure. “If I buy a $90,000 property, I don’t rent it [out] that year, and I spend $30,000 renovating it, then get it rented at the end of the year—that’s negative,” William says. “We’ve been negative out the gate. The time in renovation really costs money and costs your time and then makes it not so passive.”
Increasing Costs Kill Cash Flow
The only thing passive about investing for many people has been the tenant paydown and the equity appreciation, which, with the tax benefits of depreciation, makes the reality of buying rental properties more of a long-term play than a short-term get-rich-and-retire-early cash flow play.
Hannah Jones, senior economist at Realtor.com, said in the Realtor.com article:
“Rent softness stems largely from growing rental supply, especially in markets that boomed during the [COVID-19] pandemic. At the same time, owners are feeling the squeeze from the cost side—insurance premiums, maintenance labor, materials, and turnover expenses have all been climbing, compressing margins even where rents hold steady.”
Increasing Net Worth Is the New Goal
In a recent BiggerPockets podcast, Dave Meyer said that the magic number real estate investors needed to reach was $5 million in equity before they could even think about cash flow for personal use.
“Don’t focus on ‘Hey, I went from $500-$600 in cash flow,’” he said during the podcast. “The hard thing is building up that $5 million in equity. Once you’ve got that, it’s easy. You can just go out and buy stuff for cash.”
Low-Risk Real Estate Investment Strategies for Passive Income and Increasing Your Net Worth
If buying older rental properties in C-C+ neighborhoods equates to higher-risk investments due to deferred maintenance, the greater risk of tenants not paying rent, and escalating expenses (interest rates, upgrades, taxes, and insurance), there are ways to use real estate to build your net worth without taking on board the cash-sapping, time-consuming investment that makes investors sell their portfolios at a loss. Here are a few.
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House hack
House hacking is as old school as it gets, but it bears repeating that living in a property and then having your tenants pay some or all of the mortgage takes away one of your biggest monthly expenses, allowing you to turbocharge your savings.
The fact that you are living in the same building as your tenants usually means they will be less likely to skip out on the rent, while you are always on hand to oversee maintenance issues, making for a smoother rental experience.
Save capital gains taxes by selling your house-hacked property every five years
If you live in a personal residence for two out of every five years, you can sell it without incurring capital gains taxes on the first $250,000 as a single person and $500,000 as a married couple, according to IRS rules.
Force higher rents
Short-term or medium-term renting will increase your rents compared to a 12-month lease, provided you are in the right location and are aware of the extra maintenance involved.
Become a private money lender
This is truly a passive way to earn money in real estate. There is no dearth of wannabe flippers and BRRRR investors looking for a source of funds for their next project. If you have the cash, you can earn 12% and more on your money by lending it out.
Even if you don’t personally have the money, knowing other people who do and taking a fee for brokering a deal is also another passive form of income that involves shuffling around some papers—often with the help of an attorney or title company. Just make sure you protect the potential downside by having the first lien on the property you are lending on.
Save cash and/or liquidate assets
Buying real estate for cash takes out the major expense in owning rental properties: the mortgage. If you have cash sitting around in various assets or have saved a sizable amount through your job or the stock market, putting that money to work adds all the tax and equity advantages of owning rentals, with some cash flow on top.
If exposing your money to the vagaries of the real estate market still leaves you feeling unsettled, buying tax-free municipal bonds that generate 4%-5% in annual interest and using that to invest keeps your principal safe.
Final Thoughts
Real estate remains a great source for investing, but even in the good times of low rates and increasing rents, it was never really a passive undertaking if done properly. Now the metrics have made things even harder for investors who want to leverage—hence, the need to shift accordingly from a cash flow to an equity-growth outlook. The faster you can build your net worth, the faster you will have options to get you to a more passive investment lifestyle.
In the meantime, that means keeping your job and looking to increase your income, saving fastidiously and/or maximizing the equity on the rentals you already have through ongoing maintenance and gradual rent increases. It might not seem sexy, but being boring beats being broke every time.
