Six Ways to Make Money is Better Than One
I’ve made several comments over the years recommending real estate investing as the most powerful form of passive income.
The reason it’s so powerful compared to other passive income sources such as stocks, blogging, or bulk candy vending is: there are six ways it makes you money.
Stocks, by contrast, only share one of these sources (two if you’re getting dividends).
Income Sources of Different Passive Income-Producing Assets
Once you understand how all six of these income sources work, you will begin to see the tremendous wealth-building power of real estate bought and managed correctly.
I Said Correctly
Quick Disclaimer: These six income sources only apply to real estate bought and managed the way my mentors taught me:
A) with equity,
B) with cash flow,
C) in “bread and butter” neighborhoods,
and D) managed with best practices.
If your knee-jerk reaction is that real estate investing is too risky, you have not yet been taught how to minimize the risk. The way I was taught to invest in real estate is not the same way that many of the “gurus” teach. Most of those programs are far to risky for my taste.
Multiple Streams of Income
One neat thing about having so many different income streams is that real estate can be forgiving. Many people I know (including myself) screwed up on their first deal, but still made money. That’s because one income stream can make up for a lack of another.
Now, I don’t recommend screwing it up. You might as well do it right as long as you’re getting in the business. That way you won’t ruin your taste for the most powerful wealth-building tool available to the average person.
Let’s run down the list of the six ways:
1. Cash Flow
Cashflow is the reason we seek passive income-producing assets. Without cash flow, you don’t have income… meaning: you can’t quit your job without cash flow.
All of the assets on my comparison chart have cash flow (I’m assuming your stocks have dividends). If it doesn’t cash flow, I don’t consider it.
We don’t buy a piece of real estate unless the rental income is greater than the monthly expenses by a decent margin. For example: when your tenant pays you $1,000 a month and your monthly expenses including principal, interest, taxes, insurance, and maintenance/occupancy reserve are $800 a month. The $200 difference is now income in your pocket.
2. Equity Capture
Equity capture is when you buy an asset for less than it’s worth. In real estate, it’s when you buy a house in a $100k neighborhood for $50k, fix it up for $20k and you’re “all in” for $70k.
You just captured $30k in equity which goes directly towards your net worth. Few other investment vehicles can create wealth so quickly
In fact, of the six assets on my comparison chart, real estate investing is the only one that allows you to capture equity. Stocks are sold to the average person “at market” which, by definition, means there is no captured equity.
Without equity, you are exposing yourself to the risk of a falling market. We always buy assets with equity so that we are never hurt by a down market.
Online businesses, network marketing, and vending can be good sources of cash flow; but they don’t offer an opportunity to buy an asset for less than it’s worth.
3. Forced Appreciation
The ability to change the value of an asset by your own efforts is a very attractive reason for choosing an asset for self-determinists like me. Most of the businesses that I have ever started relied heavily on my creativity and work ethic to gain in value.
In real estate, you have the opportunity to physically change the value of an asset. In single-family investing, we take a distressed asset and raise the value back up to where it supposed to be with a proper rehab.
Multi-family investing lets us take this concept to a new level. While the value of a single-family house is constrained by the comparable sales in the neighborhood, the value of an apartment complex is based on the profits. That means you are only limited by your ability to increase the income and decrease the expenses.
The value of a vending or online business is also based on the profit margin that you can personally control.
Unfortunately, stocks do not allow you to control the value (that’s in the hands of the execs), and network marketing businesses typically can not be sold (so they don’t have a market value).
4. Market Appreciation
Real estate doubles in value every twenty years. It might fluctuate in the short term, but it is forced to rise over the long term with inflation of building materials, labor, and scarcity of land.
The main reason most people buy stocks today is for market appreciation while it’s only the 4th most important reason we buy real estate. Do you see the difference?
While stock investors live and die by market appreciation, real estate investors see it as a nice bonus to pile on top of the other five ways we make money.
5. Principal Pay Down
Here’s a neat way we make money in real estate that most people don’t even think of. We naturally accumulate equity in our houses as the notes get paid down.
Even if you weren’t making money any other way, your tenants would be paying down your mortgage a little bit each month. It starts out small, like fifty or a hundred dollars a month, but it grows over time and adds to your equity in the house.
The other asset classes typically don’t have mortgages, so this wouldn’t apply.
6. Tax Advantage
Real estate investors pay the lowest takes of any for-profit group in the United States. The IRS allows us to reduce our earned income tax on cash flow by taking a depreciation deduction against the house. We can avoid capital gains tax when we sell by using a 1031 tax exchange.
How long can you avoid taxes with a 1031? If you pass the property to your children, they will take over at the new cost basis, which wipes out all of the capital gains over the life of that asset.
None of the other assets can claim such a huge tax advantage.
Does it Make Sense?
Are you starting to understand why I talk up real estate investing so much? It’s the only asset class that I know of that can create rapid wealth. All the others make money in one or two ways, but not six.