Every income stream you add to your portfolio creates more financial security while reducing your exposure to risk. Some of the most common forms of income streams are earned income from a W-2 job, interest earned from bank accounts, residual income from royalties, or profit income from selling an asset like a boat, a car, or a painting.
I believe in owning assets that create cash flow. Because in owning cash flowing real estate assets, you have the opportunity to have seven different streams of income. Even if you’re not an active investor like myself, you can still get seven types of compensation and tax benefits for multifamily properties in the passive investor role.
#1 Fixed Preferred Return. If you’re a passive investor, you can have a fixed preferred return. It’s just like investing in a bank or the stock market, but the returns are much, much better. The passive investor partners with the active investor, or the operator, and invests a set amount like $100,000 or $200,000, and in return they receive 8-12% fixed return during the stabilization stage of a deal.
#2 Equity Ownership in Perpetuity. Equity ownership is when I pay my private lender a piece of the equity in a deal or when the passive investor gets access to everything that happens with the equity. An example of this is if we’re buying an apartment building and every apartment is owned by a separate LLC. That private lender owns a piece of that LLC forever and receives an infinite return on their investment.
#3 Cash Flow in Perpetuity. Whether an investor owns 1% or 2% of a property, once we stabilize that property and refinance it, the investor continues to own 1-2% of that property in perpetuity. Refinancing let’s them pull their capital out and reinvest in another project, but they will still receive a percentage of the property’s income forever.
#4 Equity in Perpetuity. Owning a piece of equity in the deal means that whatever the equity of a property is, the investor owns a percentage of that. It could be 0.5% or even 10%, so if a property is worth $10 million and has $3 million in equity, a 1% equity stake is equal to $30,000.
#5 Appreciation. Appreciation over time can occur because demand outstrips supply, the property was improved, or just garden-variety inflation. However it happens, it will improve your portfolio’s bottom line. As the property’s value increases, it can have a ripple effect on all of the other streams of income, bumping up profits and cash flow.
#6 Principal Paid Out. Over the life of the investment, you’re going to have some of the principal get paid out. It’s not much, but over three, five, or ten years, it adds up and continues to improve your income streams.
#7 Depreciation. This is by far one of my favorite parts about real estate investing. I own over 2,600 units of apartments, and at the end of every year I get a K9 form which is the equivalent of a 1099. Even though you made positive cash flow, because of depreciation, you’re able to show a loss on your tax return.
Investing passively in real estate will not only open up your financial portfolio to a variety of income sources, but it also helps you lower your taxes. It’s really a win-win benefit for your finances no matter which way you slice it.
MULTIFAMILY VALUE-ADD PROPERTIES
I want to give you a rough picture of one of my latest properties so that you can understand what the numbers should look like, and how you can find reputable active investors to partner with. I make no secret about how much I love Class B and Class C value-add apartments. This strategy lets me buy buildings at a deep discount and improve their net value by remodeling and then raising the units’ rents to the market rate.
We’re looking at an 80-unit apartment building that will cost us $4.3 million all in. We’re planning on getting a $3 million non-recourse loan from Fannie Mae, and we’re going to raise $1.3 million through private investors. For this property, we’re going to stabilize it by:
- Swapping out carpet for LVP
- Adding backsplashes
- Improving the kitchens
- Hiring better management
- Installing new appliances
Then we’ll be able to increase the rents by $150, and refinance the property and return our investors’ initial investment to them. We estimate that the property will be worth $6.1 million by the time we’re finished. And our passive investors will be able to enjoy the seven streams of income generated by our latest deal.
Passive real estate is still a great way to take part in real estate investing even if you’re not out there cold calling sellers and talking to commercial brokers. You still get to enjoy property appreciation, the tax benefits of depreciation, and consistent cash flow for decades and decades.
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