Is Real Estate Really Passive Income?

Editor’s Note: Dennis Fassett is a former corporate finance executive turned real estate investing “Cash Flow Mercenary.” Dennis specializes in single-family and multi-family cash flow properties and thoroughly enjoys assisting his fellow investors with their own strategies, including how to buy your first apartment building.

As an ongoing contributor to Mogul’s “Market News Updates,” Mr. Fassett provides us with his own unique, lively, and thought-provoking commentary on the timely industry news and events of today that are impacting our industry. And be sure to check out his other super-helpful Market News Updates. For now, enjoy...

From Dennis Fassett, Cash Flow Mercenary...

I get a kick out of listening to people talk authoritatively about topics when they barely know enough to be dangerous about those topics.

Talking to real estate agents about real estate investing is one such situation.

Talking to mortgage lenders about real estate investing is another.

I bring this up because I just read an article by a mortgage underwriter titled “Is Real Estate Really Passive Income?"

All I could think of when I saw the headline was that it must have been a really slow day in the office if an underwriter got tasked with writing about REI!

Writing is Subjective Anyway, Right?

Let’s take an objective look at the article and the points the author makes in addressing the question…

First - the headline is meaningless!

As I read through the article, I could tell that the guy meant rentals, but asking if real estate in general is passive is silly. After all, real estate can be:

Your personal residence
Flipping
Wholesaling
Rentals
Commercial
Industrial
Retail
Triple net
Master leasing….

And so much more that I can’t name all the different flavors or techniques.

The writer goes on to define passive income using Investopedia’s definition, which is:

"Earnings an individual derives from a rental property, limited partnership or other enterprise in which he or she is not actively involved."

Blowing Holes in This Author’s “Reasons”

He takes issue with the last part about not being “actively involved” for two reasons…

1. Not all Tenants are Good Tenants

This one qualifies him for the Captain Obvious Award.

Of course all tenants aren’t great. Or even adequate. But anyone getting into rental properties with half a brain understands that there are a ton of ways to mitigate the risk of getting a bad tenant.

The most basic is a simple background check. For $30 or less you can go online and get a comprehensive report on anyone that will provide:

A social security number validation;
An analysis of any aliases they have used;
Their credit history;
Their history of judgments (including evictions);
A 50 state criminal history;
A 50 state sex offender registry check; and
So on and so on.

A background check alone will eliminate a high percentage of the bad apples.

The downside of course is that you will have a bad tenant or tenants at some point. But when you focus heavily on doing a thorough screening for every vacancy, if you have multiple properties, the likelihood of you getting multiple bad tenants at the same time is pretty small. That will allow you to use the cash flow from the paying tenants to cover the repairs and any vacancy expenses when you occasionally have to do an eviction.

2. Landlords Have Lots of Responsibility

He says that as a rental property owner "you’re responsible for not only keeping the residence looking good but also keeping it in good shape. You need to take care of regular maintenance, repairs, and upgrades. And you must also ensure the residence is safe."

Well, yes, of course this is true. But I have found that when you buy great properties, keeping them well maintained isn’t that arduous or expensive. And if you’re doing things right and putting away a few bucks every month into a maintenance and repair fund, the money will already be available to use for this stuff.

A Few More Shots for Good Measure

So – what about his point about having to be actively involved in rental property ownership?

Well you can easily hire a good, solid property manager to handle getting a property rented and managing it. If you’ve bought a good property in a good area and you bought it at the right price, you’ll STILL have positive cash flow after paying them.

And you could even be MORE profitable by doing so. A good friend of mine has 15 rental houses in the same area that I buy in. A little over a year ago he decided to turn his whole portfolio over to a property manager, lock, stock, and barrel.

I sat down with him at a cigar bar recently and asked how it was going. He told me that while he understands that nobody will manage a property as well as you would manage your own, after paying the manager, he was actually slightly MORE profitable than he was when he was managing them himself.

How?

The manager is more focused on the properties than he was because he has a day job.

And about being actively involved in maintenance and repairs? The sum total of my involvement when an issue arises is making a phone call to someone who will handle it for me and then sending them a check after the work is done.

Look, the bottom line is that in order to have rentals that generate passive income, you need to be crystal clear on the two Critical Success Factors for owning rentals, which are:

1. Property Selection

2. Tenant Screening

If you focus on these two factors, then yes, rental properties ARE passive income. With or without a property manager.