Creating Passive Income and Building the Life of Your Dreams
by Christopher Levarek
“The only difference between the rich and the poor is how they use their time.”
- Robert Kiyosaki
If you are anything like most people, you start your day with the usual routine to get ready to head off to work.
Whether joining millions of others in jam-packed highways or more commonly these days logging online to work remotely, this is a typical start to the day.
Imagine however, at some point during the day you receive notice from your boss or company letting you know you are being let go.
Now what?
For most, this means end of income starting immediately. Yet, what if, you wisely used your W-2 income during employment and leveraged those resources effectively. What if you planned for another way of life or built other streams of income?
Three Types of Income
Did you know there are other forms of income? Most are familiar with active income however, the wealthy have learned to add in other streams of income as well in the form of “residual” and “passive” income.
Active Income
This income is generated from you working for an employer or exchanging time for money. If you stop the exchange, the income stops.
Residual Income
This income is money received after work has been completed. An example might be if you created a song or music record that provides income on each sale.
Passive Income
This income is similar to residual income however it is earned with little work on your part and continues to be earned even when you are not working. Investments in real estate for example can be one of the most reliable and easily understood source of this type of income.
As this is a real estate blog, let’s dive into the passive income and go back to the example of you losing your job. If you did lose your W-2 earnings but had passive income as well, you would still have income even if your overall salary decreased.
Imagine how much better this would feel knowing you aren’t forced to accept any new job or rush to find another source of income in this scenario. This is where the term financial freedom comes from and one commonly heard in real estate investor circles.
Most investors are seeking this financial freedom or when passive income is greater than active income thus giving one the ability to have choice or freedom.
Why not Invest in Stocks vs Real Estate for Passive Income?
Returns in the stock market vary and without going into the nuances of stock returns, let’s just look at a high level view on stocks vs real estate.
Based on historic returns, the stock market can provide about 8% annually in an index fund, most commonly chosen for stability. So if $50,000 was invested, this would produce $4,000 per year in returns or $333 per month.
Invested per year : $50,000
Returns at 8% per year : $4,000
Returns at 8% paid monthly : $333
Now if you were trying to replace your monthly income from the example active income of $4000, you would need $48,000 per year in returns or 8% of an investment of $600,000.
Not only is this a large sum to invest per year, the issue also becomes in understanding the stock or business plan, the reliability of the return as well as the need to trade $1 for $1 of stock.
Enter side stage what’s known as, leverage in real estate. With real estate, you can purchase assets without the 1 to 1 exchange. A person can purchase a $600,000 home for $120,000. How?
The bank brings the remaining $480,000.
You bring the 20% ($120,000), the bank funds 80% ($480,000) and yet, you gain 100% of the profits from the property. This is leverage, being able to buy 100% of an asset with 20% of the cash something not available with stocks.
If you were to then rent this $600,000 home for $4500 and you had a mortgage of $3000, you would net $1500 per month.
So this purchase could bring in almost half of your “active income”, ie $4000, in profits per month. If we then calculate the total rental income plus the increase in value, appreciation of say 4% annually of the property, we can see a return of 35% per year on your $120,000.
Total Rental Income ($1500 x 12): $18,000
Total Equity Appreciation annually (4% x $600,000) : $24,000
Total Return on Investment (Annual) : $42000 / $120000 = 35% return
But Wait That’s Not Passive If I’m the Landlord
So that return looks attractive especially when compared to the historical stocks but perhaps being the landlord of that rental does not.
Now this is where, partnering for real estate acquisitions makes more sense. Something more commonly known as investing in real estate syndications.
Much like stocks, you can earn the same 8% returns per year on that $50k investment based solely on the rental income or cashflows from the real estate syndication investment. Yet, typical syndications also have a return on the backend or the sale of the asset at the end of a 5 year period.
This allows investors to recoup capital and re-invest while taking advantage all the appreciation, improvements and land market value increases associated with the project or property. This increase in value allows for a higher sale of the property in the project and thus a return from the sale based on this increase in value.
So in a real estate syndication, you the investor could gain the annual return from cashflows of say 6-8% and then a return from sale of asset totally 6-8%. This would then translate to an annualized return on your invested capital of 12-14% as passive income without being a landlord. Now that will allow you to attain financial freedom far quicker than stocks.
In Final
As becomes clear, the real key in a stressful situation such as a layoff, is having alternative choices or passive income streams. By building the runway while employed, financial freedom becomes much easier to attain when needed. Who knows, you may even quit long before any such situation even arises…
Getting started is easier then you might think. Simply, sign up for our Investor Club to qualify and speak with our team on your investment goals.