When kids are learning about the world, pretty quickly they get a sense about what jobs are hard and easy, glamorous and boring, well-paying and not.
When I was growing up, there was a conventional attitude that the smart kids from wealthy families would become doctors or lawyers. After all, their parents were doctors and lawyers, and they lived in the biggest houses in the best part of town. The occasional business owner had a mansion, but to me, that seemed even less attainable than those other fancy professions.
I grew up around a business, but it was the opposite of glamorous. My grandmother owned a fish market, and my mom cut fish for many, many years. Dead fish are among my earliest memories.
Piecework
I learned a term for the sort of work my mom did: piecework. You cut a fish, and get paid a few cents for that work. If you’re out sick, or have to care for a relative? Sorry, you didn’t produce today so you’re not getting paid. The same was true for people in the garment industry and for my later “profession” as a landscaper: if it snowed and I had no lawn to mow, I didn’t get paid. Ugh.
But here’s the thing: it took me many years to realize that those fancy doctors and lawyers were doing piecework, too! If you don’t perform that heart-bypass surgery, you don’t get paid. If you’re a big-city lawyer, you might charge $500 an hour, but if you don’t work that hour, you don’t get paid.
I Discovered Passive Income
It was also many years later that I learned about the concept of passive income, and it blew me away. I remember thinking: Are you telling me that I can do work once, and be paid for it over and over? Where can I get me some of that action?
Discovering passive income was a major turning point in my life. I had done a few house rehabs but that was a lot of work, for one payday. When somebody put me on to apartment investing, my eyes were opened. I could do the work once to find, analyze, and buy the apartment, and tenants would pay me month after month.
At first I did the property management myself, but probably around the 20th time that I was bent over some toilet, unclogging it at night that I swore to myself that I’d gladly pay someone to do that work for me. It was then that apartments became truly a passive-income generator for me.
I could go on about my own story, but let’s instead step back and look at a way to think about the many investment options you have relating to passive income.
How I think about investments
It’s important to look at a few different dimensions of an investment when comparing it to other options. But first, I want to stress that I’m not an tax attorney and there are certain tests that the IRS uses to classify something officially as “passive activity income”. Here I’m simply talking in non-legal terms about how investments work in the real world.
Here are the dimensions I have found to be useful:
- How does the activity start out? Does it require active involvement, or is it passive?
- How does the activity end up? After it’s up and running, does it need active involvement, or not?
- Does the activity involve direct participation in the results of that activity (“results driven”), or is it subject to market fluctuation (“market driven”)?
It may seem confusing at first, but stick with me here.
Real Estate Investment Trusts
Let’s say you want to get involved in real estate because you’ve heard of REITs, or Real Estate Investment Trusts. This form of investing has been around for decades and some REITS have become massive. If we apply my classification system to a REIT, it:
Starts out passive; Ends up passive; Is market driven
You buy shares in a REIT, and never do any more work than click a few buttons at a brokerage house. That starts out as passive, and ends up being passive, but it’s not “passive income” to speak of. It’s like a stock, and not something that pays you continuously. You might get some dividends or they may be reinvested in the REIT. Assuming you unload your entire investment at one time, you’ll have a one-time event that is a profit or a loss.
Here’s the thing: That profit or loss is not the direct result of how the real estate portfolio did; instead, it’s the result of what the investing community is betting that it will do. It’s subject to market fluctuation, with investors gobbling up shares or unloading shares, depending on their judgment of how that REIT will perform down the road.
Is speculation a bad thing? No, but if you want to know my investing philosophy, I like to see the direct benefit of my efforts and not have them interfered with by a bunch of investors who are gambling on future results. I don’t mind if other people gamble, but I don’t like my results to be at the mercy of their various emotions and judgments.
Ecommerce Stores
This is where you make or buy a product, and then sell it online through Amazon, Etsy, eBay, or on your own site. It:
Starts out active; Ends up passive; Is results driven
There is definitely plenty of activity to begin with, but once you have the store set up—and especially if you have someone doing the packing, shipping, etc—it could be fairly passive. A store of this type will sink or swim on your own efforts, so it’s results-driven.
Affiliate Programs
This is a popular activity for people looking to make online income. Let’s say you know something about lawnmowers, the way I did, back in the day. You set up a site with a bunch of articles and reviews for different popular lawnmowers. If your information is in-depth and useful, then Google will start to show your site in the SERPs, or Search Engine Results Pages. At the end of the review for a particular lawnmower, you have a button that says “Check Amazon Price”. People who click that button will be taken to Amazon, and if they buy the lawnmower, you’ll get an affiliate fee of a few percent of the sale price. How does it rate in my system?
Starts out active; Ends up passive; Is results driven
It’s important to note that Google will ding your site for stale content; in other words, they’ll stop sending people to you. Therefore you must update an affiliate site continually. If you’re doing that work yourself, it’s definitely an “active” effort. However, you can hire people to write those articles for you, once you’ve done the legwork to build the site to the point that it can support the cost of outsourcing the writing work.
An important downside to doing affiliate websites is you tend to be a “middleman” or “middlewoman”: you don’t create the product and you often don’t know who the customers are that you refer to Amazon or wherever. Therefore you don’t create as much of an asset as if you do own the product and know the customers.
Investing in Single-Family Homes
I’ve done many hundreds of single-family home investments, so I’m a fan under the right circumstances. This investment:
Starts out active; Ends up active; Is results driven
Certainly you put in the work up front to find the property, negotiate the deal, and arrange the financing. If you’re just flipping the property then you may not have any financing, depending on how long you hold it. If you renovate the property, you stand to make more profit in exchange for all that extra work.
Fortunately, this is a results-driven type of investment. Even so, I eventually got away from doing lots of single-family deals because each property required me to do the whole process over again, for one payday. It’s possible to rent or lease single-family homes, but the return on investment tends to be lower, unless you’re in a super-hot market where you can call the shots when setting a rental price.
Investing in Multi-Family Properties
If you know anything about me, you know this is my main investment vehicle. When done the way I like to do it, the investment:
Starts out active; Ends up passive; Is results driven
There certainly is work up-front to find and negotiate the deal, but the more deals you do, the easier that up-front work becomes. That’s because you build a network of people bringing you deals, and you get comfortable with the analysis and negotiating parts.
Another aspect I like about apartment investing is that it’s less popular. Everyone knows about single-family home investing, not to mention REITs and the other investment types I’ve mentioned. That tends to drive up competition which in turn tends to drive down profits because people bid against each other more.
I’m a contrarian, so I like barriers to entry. I like it when my potential competition is scared off by the following myths:
“Apartment deals are too big for beginners to handle.” (Not true. I have plenty of students who did an apartment as their first real estate deal.)
“Apartments must require a wicked-big down payment” (Not true. There are ways to finance the properties with other people’s money and that’s the case even for your first deal.)
“I sure don’t want to be unclogging toilets on Christmas day.” (Neither do I! That’s why I hire management companies to do all the daily work at my properties.)
The list goes on. Can you make mistakes at investing in multi-family deals? Sure. I’ve made plenty. Do they require work up front to learn how to do? Yes they do. Are the results guaranteed? Nope. But once you get the hang of investing this way, life will never be the same again, in the good sense of the word.
Limited Partnership Investments
These are sometimes called “Regulation D” deals, or “Reg D” deals, or “private placements”. They involve a general partner who puts the investment together and runs it. Limited partners put up some of the money to finance the asset, which can be real estate, oil drilling, cattle farming, equipment leasing, or just about anything. From the limited partners’ point of view, this type of investment:
Starts out passive; Ends up passive; Is results driven
In the heyday of the 1970s, these investments were sometimes called “tax shelters” because you could legally get tremendous tax savings for investing in certain types of assets. The tax laws changed and though there may be some tax advantages still, investors mainly get involved in limited partnerships for cash flow, appreciation, or both.
Even though these investments start out passive, they do require quite a bit of analysis to know which ones are any good. They all sound like good investments by the people who promote them, but in reality they range from great to downright awful. One other factor with limited partnerships is you basically cannot sell your shares; you’re in this investment for the full ride, sink or swim.
Where to go from here
Though this article has been a tour of some of the most-common types of investments that may generate passive income at some point, my main focus, as I said, is multi-family investing. To my knowledge, no one else in America has as much information about apartment investing as I have created over the last two decades.
I’m a “prove it to me” kind of guy, who wants to see evidence that something works before I get deeply involved with it. If you’re the same way, then good for you! It’s the only way to separate the “shiny object” sexy investment pitches from the tried-and-true systems out there.