Fox Business has an interesting post on passive income in general and rental real estate as passive income in specific. After having been a rental real estate investor for two years now, I definitely have some thoughts on this issue.
But let's start with what Fox says. Here's what they list as the definition of passive income:
Investopedia describes passive income as "earnings an individual derives from a rental property, limited partnership or other enterprise in which he or she is not actively involved."
Later the author clarifies his thoughts by saying the following:
Real passive income is earned in your sleep and regardless of the amount of effort you put into it.
Then they give a bit of a reality check:
Becoming a landlord might sound tempting, but -- trust me -- it's not as glamorous as it seems. It's also not nearly as passive as many think it to be, despite what Investopedia or others claim. As someone who has owned and managed two single-family rental properties for almost a decade, I must confess that the income I've earned has been anything but effortless. The truth: It's actually been a lot of work.
Some thoughts from me:
1. The U.S tax code does list rental real estate as passive income. One thing this means is that any losses incurred can only be used to offset passive income -- not active income (like you earn from your job or side business). I found this out in year one when my first property was being renovated and I had expenses, but no income. The losses weren't deductible that year because I had no passive income to offset them. (I was able to deduct them in year 2 as income started to flow in.)
2. While rental real estate may allow you to earn income in your sleep, it is subject to the amount of effort you put in. You don't just buy a place and start earning income, there's a LOT of work that goes into getting it ready, finding a tenant, and so forth. Even after you place a tenant, there are repairs, bills to be paid, etc. that require your time and attention, especially if you manage the properties yourself.
3. And even if you have a property manager, like I do, it's still not completely hands off. I am in communication with my manager at least once a week. Over the past two years I've been in weekly communication with the guy remodeling my units. I still have to manage the insurance, taxes, and finances for the properties. I visit them when needed (I now live in Oklahoma and they are in Michigan, so I'm not sure how often I'll see them). Yes, my manger handles the 3 am toilet plug issues (I still pay for the repairs), but there's still plenty of work to go around.
4. Early on in my real estate investing career, I spent a TON of time learning the business, learning the market, looking at properties, considering bids, and on and on. It required a lot of time and effort.
So I would not classify rental real estate as a passive investment. Even something that's mostly passive (like writing an ebook one time, putting it on a website, and earning sales from it) still requires some effort. You may have to update the book, make sure the site is up, handle returns, and so forth. Yes, it's mostly passive, but not completely.
Rental real estate isn't even most passive. Sure, it's not as much work as 40+ hours at a job each week. But you have to put in a decent amount of time and effort if you want to maximize the income from your investment.
BTW, don't get me wrong. I LOVE rental real estate and am glad I own it. I'm just saying it's not all rainbows and lollipops. It requires work.
That's my take on the issue. What's yours?