We are at the age in which people have increasingly become financially savvy in such a way that we get to talk about passive income now more than ever. The generations before us were fairly contented with the income they get from the usual 9–5 job, and rightly so because money had more value then than it has at present. Nowadays, you just can’t live with one source of income alone and expect to be financially free right away.
Hence, passive income comes into play. Passive is defined as something that happens without your direct participation. Income is, well, money derived from investments, work, or labor.
When we talk about passive income, what’s the first thing that comes to your mind? Is it effortless income? Income that goes directly into your bank account without you lifting a single finger? If those are your definitions of a passive income, then you belong to most of the population.
However, our definition of passive income is different. The notion that passive income requires no effort is dreamy at best. Let’s take income through dividends as an example. You can argue that to earn it, you won’t have to do anything; but in the first place, you must have the capital to earn interest as dividends.
Hence, passive income does not equate to effortless income. Nothing is free. Every form of passive income requires an initial investment in terms of time, capital, or effort. However, passive income differs from traditional income because, with passive income, you only have to spend time to set it up during the initial phase and leave it running once it’s set up, and it may be minimal time. So passive income is not directly tied to your time.
In traditional 9–5 jobs, you have to spend a uniform 8 hours per day 5 days a week to earn your salary. However, in passive income, time is typically necessary during the establishment only, and minimally after that.
With traditional income, your earnings are affected or interrupted if you take some time off. With passive income, a system is in place; thus, the benefits continue to pour regardless of whether you participate or not. Investing in passive real estate is the perfect example.
Passive real estate is a type of investing wherein you invest in other people’s deals through syndication. Syndications are managed by professionals. They are in the business of buying and selling properties and almost everything in between. They sometimes need outside capital to be able to expand, and that’s where you come in.
In this scenario, the large amount of work required in traditional methods of investing in real estate is reduced.
Although syndications are attractive, you have to take note that your first goal in investing is to protect your capital; thus, performing proper due diligence upfront is extremely important. Once this assessment is done and all goes well, you can just expect the investment to bear fruits soon.
This act of strategically using your available resources to generate a high amount of income is technically called leverage.
What Is Leverage?
In your science class in second or third grade, you may have learned that if you’re having trouble lifting something heavy, using a lever may be able to do the trick.
When you’re having a challenge in buying something with your own available resources, you use leverage. This concept is not new, and you probably have done this before. When you bought a house, you borrow from a bank so you only put up a 20% down payment instead of paying the full price of the house. In this scenario, the bank acted as your leverage (putting up the 80% remaining balance in exchange for the house in case of default).
How Leverage Is Applied in Real Estate
In real estate, leverage can be in different forms. The first, of course, is the example earlier regarding money or capital.
Let’s say you have $100,000. You can choose to use that as a down payment for a $500,000 property and earn income from that one property. That’s a great idea, right? Sure! But going through this route means your possible income is tied to that one property. What happens if it doesn’t pan out as planned?
This is where you can use your capital as leverage one step further. You can use the same investment capital of $100,000 as part of a syndicate. Syndications pool money from different investors.
Your initial $100,000 will have more purchasing power once pooled together with other investments pledges. That means your money can go toward a larger, more profitable deal than you could afford alone.
Financial strength is the second form of leverage that we’d like to discuss. Financial strength can be briefly described as how sound your inflow and outflow of cash are, namely your balance sheets, when getting into investments.
Think of it as your credit score but from a business perspective. When you undertake a real estate project on your own, you bear the necessary expenses and possible risks out of your own pocket. Again, if the deal doesn’t work out, you will bear the brunt of the damage.
However, if you invest in pooled investments such as syndications, you don’t have to worry about things such as balance sheets and financial health because banks look at the balance sheet of the company managing the syndications and not your own.
Why is participating in pooled investments crucial? First, doing so allows for a large room for expansion. Usually, the larger the syndication is, the sounder its position is. Large syndications have advantageous access to capital. Therefore, banks are inclined to further grant them loans, thereby allowing these companies to invest in other properties, and the cycle goes on.
At this juncture, you probably get the idea how joining a syndication might be in your best interest compared to getting in on your own. Another thing you can leverage by joining a syndication is their knowledge and experience.
How long does it take for one to master something? Let’s use physicians as an example. Before they acquire their license and become consultants, they have to go through 10 years of education. Similarly, no one becomes a real estate expert overnight. It takes years and years of experience to become one.
By investing in a syndication, you can have access to the company’s vast amount of knowledge and experience without having to go through all the process yourself. This situation is perfect for (1) those who are just getting started because you don’t have to devote much of your precious time learning the ropes because doing so may result in missing out on lots of opportunities and (2) those who don’t want to be bothered about the intricacies of real estate investing. They can just simply put their trust in the company (after due diligence, of course), and let the money run the investment for them.
Usually, a syndication already has a team of experts who are knowledgeable when it comes to spotting the best real estate deals in the market. This built-out team is another aspect you can leverage on. Imagine having access to a team of specialists who can give you sound business advice. This team also has the technical knowledge on how to make each property deal profitable consistently. The best part is you don’t have to build this team from scratch!
Last, but certainly not least because it is possibly the most important, is time. Building a profitable real estate portfolio entails mind-wracking effort and a huge amount of time. That is time that you may not have or may be better spent elsewhere (such as with the ones you love or with self-improvement activities).
When investing in passive real estate projects, you’re leveraging the limited time that you have. You may invest time upfront (during due diligence), but compared to the years of passive income a good investment can bring, that time is well worth it.
Instead of doing everything firsthand, that is, trading time for money, you will only spend a small amount of time for great, long-term benefits, like hanging out with family, friends, traveling, or just enjoying life in general.
You can argue that building a passive income should be worth your time, and you’re correct. Between working hard and working smart, why not choose the latter? If you can take advantage of a vehicle that can bring you to your destination (that is, financial freedom) quickly, why not choose that?
Conclusion
Leverage is a powerful tool. If you learn to use leverage together with passive income and real estate investments, you will become a sophisticated and efficient investor. Most importantly, you can achieve your financial goals quickly, thereby having time to spend on other important things in life.
At the end of the day, our ultimate goal isn’t simply to make a great investment but to make an investment that will allow us to live the life we want and to have the time to spend with the people who are special to us.