Are you an entrepreneur that wants to invest in real estate without the hassle?
Real estate investors spend tons of cash and time on finding the most potentially lucrative properties to buy and flip or rent.
This process involves a lot of research and suffers from a number of unknowns and setbacks from hidden structural problems, construction and renovation headaches, unskilled or unmotivated labor and volatile local markets that may not bring a return on investment.
Ryan Moran, entrepreneur, business leader and CEO of Capitalism.com, notes that purchasing real estate could be a costly mistakes for entrepreneurs who are looking for truly passive forms of income.
In a recent video on real estate investment, Moran mentions a few ways for entrepreneurs to take advantage of the profits found in real estate investment without investing too much time or sweat. As the real estate market improves profitable flip deals will become less and less common, and the cost of property management, taxes and maintenance on single family homes will eat away at diminishing returns. If you are an entrepreneur who wants to make sizeable, passive income in real estate without making it your primary business pay attention.
Real Estate Investment Trusts (REITs)
REITs allow individuals to invest in large, income producing properties like shopping malls, office buildings and apartment complexes. Unlike traditional real estate companies, a REIT buys and develops properties and pays dividends to investors from rental income. Investors can either invest in a publicly traded REIT or buy into non-traded REITs through a broker. For first time investors, non-traded REITs may be a little steep as investors pay sales commissions and offering fees that eat up approximately 9 to 10 percent of profits. Publicly traded REITs are an easy form of passive income that leaves the procurement and management of rental properties to the experts, while investors enjoy annual checks in the mail. Not to mention the tax benefits. Many REITs offer 100 percent of their taxable income to shareholders who then pay the taxes on the dividends.
Hard Money Lending
If you want to make passive income in real estate, you can look into becoming a hard money lender. Investing in hard money loans or private loans is similar to investing in bonds. These loans return a fixed yield and pay off at maturity. Entrepreneurs in this case supply the capital for the real estate investor who does the heavy lifting of buying, renovating and flipping properties. This is a win-win scenario for entrepreneurs as they reap the rewards of real estate investment without having to compete against seasoned real estate investors. Although hard money lenders avoid an active role in real estate procurement and management, they still must understand the basics and perform due diligence for each contract. If managed correctly, hard money loan returns can exceed the buying or selling of stock.
So how does a hard money loan work exactly? Here is an example: Investor A makes a loan to a borrower for $90,000 at 8.00% interest, and requires interest-only payments. Investor A will earn an income of $7,200 every year. And if the loan does not go into default, it will pay off at or before the loan matures. If you want a passive income where you have absolutely no involvement or responsibility, private lending and hard money lending may not be the perfect fit. According to Private Money Lending Guide, there is still a fair amount of oversight and paperwork required.
Requirements and Best Practices for Hard Money Lending
- Title Insurance: Title insurance offers some protection and insures your lien position as the lender and offers fraud protection against forgery. Title insurance is an indemnity policy. Therefore, if there were a loss title insurance would only cover the loss.
- Hard Money Lender Insurance: Make sure the property owner has all the required fire and liability insurance. Notify the insurance company so you are included on the insurance policy as the private lender. If there is a loss, this ensures that the insurance check comes to you first. Check with an insurance company that specializes in writing for real estate investment properties
- Borrower Credit: Before dishing out thousands of dollars, investors should carefully consider a borrower’s credit history and capacity to make monthly payments on the loan. In addition, review the borrower’s assets, collateral, and the borrower’s ability to repay the loan when the loan matures or if a balloon payment is due at the end.
- Documentation: Consult with an attorney or proper counsel to create the appropriate security documents and disclosures for the borrower to sign. This paperwork is often regulated by the state and federal government. Any errors or oversights on these documents could invalidate the loan.
Participate in Real Estate Syndications and Real Estate Funds
If you are confident in your investment partners and the business model, real estate syndications and funds is one of the easiest and predictable forms of passive income for real estate minded entrepreneurs. So how does it work? Let’s say two guys open a restaurant. The Sponsor is the daily manager that does the heavy lifting like, raising funds for the property, hiring the staff, and managing the day-to-day operations. Meanwhile, the Investor provides the financial backing. The Sponsor will generally invest up to 20% of the total required equity capital, and the investor puts down as much as 95%.
Unlike hard money lending, syndications are less complex to create and come with built-in protections for everyone. Many syndications are structured as Limited Liability Companies or Limited Partnerships. The rights and responsibilities of Investors and the Sponsor are included in the LLC Operating Agreement or LP Partnership Agreement.
Real Estate Syndication Profits
So how do investors make money in a real estate syndication? RealtyShares explains that syndications make their money through rental income and property appreciation. Rental income is distributed to investors from the Sponsor on a determined date. If the Sponsor has done their research, picked a good location and has a solid business plan, the property’s value should appreciate over time. As a result, Investors net higher rents as time goes on and make even more money when the property is sold. Payment schedules vary from business to business. This largely depends on how long it takes the investment to mature. Some syndications take several years, while others take 6-12 months. The Sponsor receives their share of the profits after all Investors receive a ‘preferred return,’ which is a benchmark payment that is around 5-10% of the initial money invested.
Advantages of Real Estate Syndications
What are the advantages of investing in a real estate syndication for an entrepreneur? A truly passive and profitable income stream first off and tax deferred status until the property is sold. Here are a few more advantages.
- High Returns without the Risk: Real estate syndication provides an additional level of protection for investors as structural guidelines ensure that investors are only responsible for bringing cash to the table and are not responsible for the fund’s performance. This shields investors from any potential lawsuits due to fund-related activities. So now you can leverage the Sponsor’s knowledge and talents with your capital, while also distancing yourself from liability and receive big gains as a passive partner.
- The Opportunity to Invest Big: Investors that don’t have $100,000 to invest in large scale commercial and residential properties now can because they have the opportunity to put as little as $10,000 into a pool with other investors. This gives smaller investors the ability to own a percentage of huge commercial projects like storage facilities, malls and mobile home parks.
- Diversification: Real estate syndications allow you to put your money in multiple properties without finding and buying each one. For example, instead of buying a property for $50,000, instead you put that $50,000 into a real estate syndication where ten investors each invest $50,000. You will now own 10% of the fund’s profits from rents collected and property appreciation. As you acquire more funds, you can then place money in other pools which gives even more protection against vacancies or the failure to perform of a single property.
Entrepreneurs that want to continue to grow their wealth with passive means of income should definitely consider investing in real estate. However, buying individual properties to flip or rent out may not be the most efficient and passive way to earn more money. Any “passive income” opportunity that detracts from your main business is a distraction and could hurt your cash flow, so make sure whatever passive income streams you pursue, don’t require much more effort than capital.
Experienced entrepreneurs know that unbelievable profits can be earned through focusing on their primary business and investing their profits into other businesses for passive income streams that provide tax advantages, steady and trackable profits, the opportunity for portfolio diversification, dividends to place back into your primary business or into your hobbies, and eventually your financial freedom.
