As an investor, are you reinvesting your income? If not, then you could be missing out on a world of exciting long-term benefits.
If you are working towards financial freedom, early retirement, or any other long-term goals for wealth creation, then you might consider re-investing your passive income. While this may require a short-term sacrifice, the long-term rewards mean that with hard work, this strategy is one that can pay off, and help expedite the process of reaching those goals.
Want to learn more about getting started with passive income? In this article, we’ll take a look at what it is and how you can start generating it.
What is Passive Income?
First up, what exactly is passive income? Passive income is income that is made without having to actively work for it. It is important to note that while you might not be actively showing up to a job site to earn an income, you will be putting effort into building the process. So it’ll require an initial outlay of time.
Passive income doesn’t come from an employer or a contractor. While you may be putting a lot of sweat, blood, and tears into your rentals, you won’t be actively working to receive the income. Eventually, your rentals will be working for you and you will be making passive income.
There will be work involved to get you to the point of earning passive income though, such as repairing, remodeling, finding a property management company, and maintaining long-term occupancy with happy renters, just to name a few. Once you get things rolling in the right direction, your investment property will begin to do the work for you.
Benefits of Reinvesting Passive Income
Passive income can help you reach your goals of financial freedom, but re-investing that income will result in a host of additional benefits. Here are just a few.
- The Ability to Scale Faster
Every investor should set long-term financial goals that they’d like to achieve through their real estate investments. Reinvesting can help you to grow your portfolio at a much faster rate.
- Additional Income
Reinvesting your income can help you grow your portfolio and increase your bottom line. Even if you have already reached your financial goals, you can benefit from reinvesting and receiving an additional income.
- Better Loan Terms
Assuming you save up enough money, you can use your passive income to purchase another property with a 20% downpayment. This means that you’ll be able to avoid PMI (mortgage insurance), which can be costly. With a larger down payment, you may also be able to qualify for a lower interest rate, which could represent a considerable savings each month.
How to Create Passive Income
Ready to get started creating passive income? It might be easier than you think. Don’t let the name fool you, there will be plenty of work involved to get you to the point of earning passive income, but once you get the ball rolling you will be creating passive income without much work involved, or at least not the 8 to 5 shift that most think of when it comes to working for their wealth.
Here are some different ways that you can create passive income, or alternative options for reinvesting your passive income to help diversify your portfolio.
- Single-Family Rentals
The most common and perhaps simplest way to get started is with your basic single-family rental unit. Starting with a single-family unit will allow you to get your feet wet with only one tenant, one property, and one set of rules. The downside to single-family units, is that when your tenants leave, you won’t have any other ‘backup’ units to bring in income or carry you through until you find new tenants. Still, a good good property manager should be able to help you fill those vacancies fairly quickly.
- Multifamily Units
Duplex or triplex properties come with a lower risk when it comes to vacancies; if you lose one tenant in one unit, you still have the other (or others) to help balance things out until you find new tenants. The management responsibility increases a bit with a duplex or triplex as you have more units to manage and can be increasingly difficult to keep up with if you don’t have outside help.
- Apartment Buildings
Apartment buildings are also great ways to create passive income and allow you to scale quickly. Of course, the level of work that’s involved with overseeing an apartment complex goes up significantly compared to a single-family unit and you should be prepared for this.
- Vacation Rentals
Vacation rentals such as Airbnb can be a good investment option, however, this type of income is much less passive than a traditional rental. While vacation rentals in popular destinations can charge what they want per night, these short-term rentals are generally seasonal and require a great deal of upkeep and care and can experience off-season vacancies as well.
- REITs
Real Estate Investment Trusts (REITs) are a great way to add some diversification to your portfolio. A REIT is a company that owns and generally manages, real estate that is generating income. You can invest in REITs without having to buy or manage the actual property itself. REITs are popular ways to grow passive income since they require very little actual work or involvement.
REITs don’t come without their own unique set of risks, and it’s important to keep some of them in mind. The downsides of REITs includes the following:
- You don’t own the property
- It doesn’t appreciate in value
- You might not have cash flow in a downturn
- The property has a lack of liquidity
- There are additional fees to consider
Do your individual research to see if REITs are ideal for your long-term goals and investment needs.
- Upgrade Your Current Properties
A well-timed remodel could be another good way to re-invest your passive income. Just be sure to ensure that the upgrade is something that will actually increase not only your property’s value but the asking rent. Good upgrades that tenants are often willing to pay more for include washing machines, dishwashers, or a new fridge. Hard-wearing flooring as opposed to carpet can also be a good investment. It’ll last longer, and tenants will view this upgrade as more high-end.
Looking for some improvements that could potentially increase your home’s value? Check out: Long-Term Investments Upgrades That Can Last a Lifetime in Your Unit, for some ideas.
Passive Income: Investment Mistakes to Avoid
Like all investment opportunities, there are pros and cons associated with whichever route you choose. When it comes to re-investing your passive income, there are a few mistakes you should be aware of so you can hopefully avoid them. Here are a few of the more common pitfalls that can occur when re-investing.
- Not Having Enough Cash Flow
In order to reinvest your passive income, it is especially important that you have adequate cash flow. Be sure to run the numbers carefully before investing.
- Failing to Properly Screen Tenants
Perhaps the biggest mistake to avoid when investing is rushing the tenant screening process. Make sure you take the time to thoroughly screen your applicants to ensure that you find a qualified tenant who is able to pay the rent and abide by the terms of the lease. Once you have tenants, you should set about making sure they are happy so they want to stay longer. The lower your tenant turnover rates, the higher your passive income. In most cases, keeping your tenants happy enough to stay takes less work than trying to find another tenant.
- Avoiding Management
In order for your real estate investments to be truly passive, you’re going to need to outsource rental management to a property manager. Good management can help reduce tenant turnover rates, prevent expensive repairs, and even improve your property value, all things that will help boost your bottom line.
- Collecting Rent Late
Another pitfall to avoid is not collecting the rent on time or not following through with late fees. It is important to be clear about the rules upfront and then follow through later on. Allowing late payments is damaging to your cash flow. It can also damage your reputation as a landlord. If you have a multi-family dwelling, your other tenants might hear that you do not enforce late fees and may feel tempted to pay late as well. Set clear rules, follow-through, and be consistent.
Don’t Forget About Leverage
Finally, while reinvesting your cash flow is important, another way to grow your portfolio is by looking to use leverage. With leverage, you use other people’s money (namely, the bank’s), to grow your portfolio. While you put in a certain percentage of your own funds, by using a loan, your returns will be higher. Think about it this way, you could pay 100% cash for a 100k property, or you could make a 20% down payment on five $100,000 properties. With one property, your returns will be minimal. With five, you’ll be generating five times as much income and experiencing appreciation on five assets. It’s a great opportunity to grow your portfolio faster.
In most cases, leveraging allows you an opportunity to maximize your returns on your investment. There are a few different ways that you can successfully use leverage to grow your portfolio.
If you are looking to build or grow your long-term wealth and real estate portfolio, then you should give serious consideration to reinvesting your passive income. You might be making an income now, but if you re-invest, you can potentially grow your income faster, allowing you to build your wealth faster as well. This will help you to become that much closer to your big-picture goals, and your dream of financial freedom.
Looking for a property to re-invest your passive income? Be sure to search the Renters Warehouse Inventory of available houses that could fit the bill.
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