I do enjoy swimming through the blogosphere from time to time like an amoebic creature coasting to the soft ambient sounds in flOw... One of the blogs that I enjoy reading is called The Simple Dollar, and he had a curious post written the other day. It was about some search phrases that people had typed into "the Google oracle" which had led them to his blog. One caught my eye in particular:
How can i build passive income?This brings up a familiar phrase to all who have either invested, or thought about investing, in real estate. "Passive Income". How passive is real estate income really? To answer that question, I went back through my e-mails, my records and recollections to try to understand how time-intensive my investing has been. The answer probably will not surprise you, but it's still straight from the horse's mouth.
Passive income (money that comes in with little or no maintenance effort from yourself) requires extensive capital up front in the form of money, intellectual property, or effort. Sources of passive income include fully-managed properties, web sites, and so on. So how can you build it? You need to invest something of your own into it, whether it be money or ideas or work. Buy a managed property. Start a blog. Write a book. Record some music. Then sell what you’ve got. Over the long haul, money will trickle into your coffers once you’ve put forth that initial capital.
Real estate investing can really be broken up into 5 phases. Each phase has it's own unique demand on your skills and your time. Not every investor comes across every phase, but your entire real estate experience will probably fall into one of these phases at any time.
- Analyzing, purchasing and/or selling property
- Property renovation
- Finding and preparing for new tenants
- Tenant care
Phase 1: Analyzing, purchasing and/or selling property - 25-100+ hours
Figures that we start with the least definable category. This category could vastly differ from investor to investor, so let's break it down into parts.
Analyzing property is very different for every investor. Your investment strategy could be as simply as noticing that the house next door is going up for sale and making an offer (yes, that counts as investing too). Other investor could scrutinize the MLS every day looking for new deals. Everyone is different and everyone will spend different amounts of time looking for good opportunities.
Purchasing property can also vary from investor to investor, but there are some concrete steps that you have to go through. You need to line up a lender and you need to find insurance. Biff and I always compare at least three lenders, and expect to put in about 20-30 hours on the phones looking at our options. That's partially because we also compare the costs of larger 90% loans to 80/10s or 80/15s. Once we've locked in our lender, it usually takes about 10 hours between the two of us to get out paperwork lined up and submitted(about 5 hours each). Insurance took us about 10 hours of phone work to make our initial comparisons, but now we stick with the same provider (so we spend less than an hour getting it set up for new properties). You also need to deal with the offer paperwork, and negotiating the deal, which can take anywhere from 5 to 15 hours. Finally you have to close on the house, which usually takes about 3 hours, and do a final walk through which can take another 1 hour.
Also, the first time you buy an investment home, there is more overhead to consider. You need to write up a lease, set up bank accounts, figure out how to run a credit report. All in all, that overhead can add another 15 hours to your budget. But once it's taken care of, usually you can just reuse that work in the future (you may adjust your lease, but it's unlikely that you'll re-write it).
Selling properties is something that Biff and I haven't yet experienced, so I don't want to comment on it too much. But your time cost will vary greatly if you decide to sell the property yourself rather than use an agent.
Phase 2: Property Renovation - At least 20 hours a month
This is an area that Biff and I have never experienced, so again I don't want to get too deeply involved. But as one of my co-workers is currently renovating a house in London I thought I'd make a couple of observations.
There are two ways of renovating a home. If you are renovating it yourself, expect it to soak up at least 40-50 hours a week of your time. It's a long hard process that will be quite draining. If you don't make it your full-time occupation, you'll probably find your renovations dragging on for months. However, as you see on TV, many professional investors are well-trained and equipped to deal with renovation and do almost all the work themselves. It is their full-time job.
If you instead opt to pay other people to do the work, still expect to spend at least 20 hours a month working on the home. Though the contractors are doing the labor, you will be working on the budget, handling any crises that occur and making every decision (from the type of tile you want to the location of the walls).
Renovating homes is a very time consuming process, and certainly belongs more in the realm of full-time investing than "passive" investing.
Phase 3: Finding and preparing for new tenants - 15-35 hours a month
If you intend to manage your property (for the love of all that is good in this world, please don't use a property management firm), then you are going to have to find tenants for your properties. When ever you buy a new property or lose a current tenant, your search for a new one will include:
- Advertising the opening
- Dealing with phone calls and e-mail inquiries
- Showing the property
- Reading applications
- Running credit reports
*Note that we don't spend 15-20 hours every month on our tenant search, we just spend approximately that much time when we have an opening. And since the same tenant can stay renew their lease multiple times, these 25 hours spent in one month could end up amortizing over years.
In addition you need to clean up the house between tenants. This usually includes painting, windexing, vacuuming and scrubbing most every surface in the house. Biff and I usually make a day out of this, for a time cost between the two of us of about 20 hours. The time, of course, varies depending on how large the unit is (a studio apartment or a single fmaily home?) and the amount of work needed to be done.
One semi-creative solution is to find a workforce of friends and/or kids who can help you paint and clean. Just offer them an age-appropriate combination of pizza, beer and soda as their reward.
Phase 4: Tenant Care - About 5-8 hours a month*
This is why real estate is considered "passive income". Note that the time commitment above is entirely based on Biff and I's experience and your mileage may vary.
On an average month I typically spend a couple of hours on the Internet, making sure that rent was deposited and the mortgage was paid on time, and updating our books. Biff, on average, will spend a couple of hours fielding calls from tenants and answering questions. Note that this is an average. Some months may pass where he gets no calls, and others come where he spends several hours getting a repairman to come and fix the air-conditioning.
*Still, at any time a major crisis could occur and we'd probably be on the phones all day trying to fix it. That hasn't happened yet and most likely won't happen often. But eventually it's likely that we will have to deal with a significant problem.
Phase 5: Taxes - About 30 hours a year
I'll admit, your taxes might be a lot easier than mine. Since I do taxes for both myself, my wife and Biff (our real estate gains and losses have to be split between the two of us), my taxes can often take a very long time. If I owned the properties just by myself, then I would likely be able to finish them far more quickly, probably in just 5 hours or so.
Also note that my taxes get done relatively quickly for one reason. My books. I keep very precise books all year long, detailing every business expense, when it occurred, how it was paid for, and even logging all my mileage. When tax time comes around it's a simple matter of opening my spread sheet and totaling the columns. If you don't keep very careful track of your records, you may find taxes taking you a ridiculous amount of time.
So there you have it. Real estate requires constant availability (if something goes wrong, you have to be prepared to respond), but it doesn't always require a great deal of attention. However, if you are after some truly passive income, I strongly suggest investing in stocks. That requires nearly no time investment at all (other than getting a basic education of how to invest), and is truly passive.
Real estate, as I've said before, is a business and requires the time and commitment of all small businesses (though on a slightly smaller scale). If being a business owner excites you, as does keeping corporate books, then this is probably the right type of vehicle to put your money in.