The term “passive income” effectively refers to assets which require minimal management yet create long-term income streams. There are many different forms of passive income you can create from real estate which can prove especially useful in retirement. In some ways the term “passive” is a little misleading because there is initial work to do and the investment must be structured correctly to maximise income and minimise day to day involvement. We will now take a look at some of the more common forms of passive income and how they can impact your long-term wealth.
Buy to let property
Perhaps the best-known form of real estate passive income is that created by buy to let properties. The idea is simple; an investor researches the best buy to let real estate, acquires a property and rents it to tenants on a long-term basis. While there will be annual tasks to carry out in terms of health and safety, and potentially repairs and maintenance, if structured correctly this can be an extremely lucrative passive income stream.
There will be occasions where investors would prefer to distance themselves from the property once they have acquired the asset. In essence they are looking for a property management company that will charge a fee to manage their property. This could include everything from finding new tenants to chasing rent arrears, property maintenance to significant repairs and more. The appointment of a property management company is a further step away from the more active side of real estate investment.
Real Estate Investment Trusts
Real Estate Investment Trusts, otherwise known as REITs, are what is commonly referred to as a form of collective investment. These highly tax efficient structures revolve around a holding company which will own property assets. Shareholders own a share of the company and therefore a share of the long-term capital growth and income from the property assets. The reason why this type of investment is seen as passive is because you buy the shares and the property assets are managed by a third party.
One of the benefits of REITs is the fact that unlike the acquisition of individual properties, you will be able to buy and sell REITs shares in what are often liquid markets. As a consequence, if you want to invest/redeem property funds you do not need to go through the whole process of buying and selling individual real estate assets. You simply buy and sell the shares in the holding company – in the secondary market.
Real estate crowdfunding
Over the last few years we have seen a huge increase in crowdfunding activity related to real estate. In a similar manner to REITs, crowdfunding allows investors to invest what can be relatively small amounts of money into real estate. The two main options when it comes to real estate crowdfunding are equity investment and loan notes. Equity investment tends to be more volatile as the investor would benefit from changes in rental income and potential capital appreciation. The fact that none of these are guaranteed for equity shareholders makes this type of investment more risky than loan notes.
Real estate loan notes are commonly offered on real estate crowdfunding platforms as a means of creating a steady income for investors and allowing developers to raise funds. Developers will create a special purpose vehicle (SPV) into which the loan note investment is channelled for the sole purpose of acquiring property. This ensures that properties can be held separately from parent companies, protecting them from any financial problems going forward. Traditionally an SPV would cease to exist when the property has been sold and funds distributed to investors. In this scenario a third party, the developer, would be in charge of managing the property asset(s) with both equity and loan note investors taking no active role.
Houses in Multiple Occupation (HMOs) have attracted significant investment in recent times. In simple terms these are properties which have “common areas” that are shared by more than one household within the property. The idea is relatively simple; acquire a large property/family home and subdivide it into various living spaces for unconnected third-party. There will be common areas such as kitchen, TV room, etc which lay side-by-side private accommodation areas for each party.
The capital required to create an HMO will vary depending on location, structural changes needed and other issues such as local taxes etc. Once the property has been split into “common areas” and private living quarters it is simply a case of seeking tenants and collecting rental income. If structured correctly this can be a relatively passive form of income although as with buy to let investments there may be repairs and maintenance required from time to time. It is also possible to take an even further step backwards from active involvement by appointing a property management company to look after the day-to-day issues.
Furnished holiday lets
Over the last few years we have seen the introduction of additional buy to let real estate taxes in the UK. This seems to have encouraged investors to consider furnished holiday lets which are effectively treated as stand-alone businesses and operate under a very different tax structure to privately held buy to let properties. The idea is relatively simple, acquire a property in an area popular with holidaymakers, add furnishings and let to clients on short-term arrangements.
Many investors choose to have their furnished holiday lets looked after by property management companies – thereby taking them one step further away from active involvement. There are obviously costs associated with a property management company but the overall benefit will depend upon the investor’s degree of experience and availability to manage day-to-day requirements. As with any real estate based passive income, the focus is on the long-term rental cash flow and potential for capital appreciation.
The potential opportunities for passive income in real estate are huge although the long-term success and income streams will depend upon the initial setup of the property. One area which has proven to be very popular of late is self-storage facilities which attract both short-term and long-term clients. There are many reasons why you may require self-storage facilities from merging family homes to business stock, long-term investment opportunities to the accumulation of office furniture.
The Holy Grail of real estate investment is the long-term tenant who pays on time, requires very little if any servicing and treats the property with respect. With self-storage facilities you may need to visit the premises for an inspection once or twice a year although there will be times when you may need to find a new tenant. On the whole, this can be a relatively lucrative form of passive income often requiring little in the way of active management.
There are numerous opportunities and ways in which you can create long-term passive income streams. Each will have a varying degree of involvement which can be deemed as passive. We regularly come across investors who take on buy to let assets which run smoothly and only require the statutory annual checks. At the other end of the spectrum many real estate investors looking towards long-term capital appreciation and passive income streams will employ the services of property management companies. In effect the property management company take on all of the day-to-day management activities and the underlying investor would have very little to do.
Many people see passive income from a real estate portfolio as a means of replacing income from their working life as and when they retire. It will therefore take long-term planning, structuring and appreciation of the changing regulatory environment. For those while to research potential prospects, and take a long term view, there are many opportunities out there.