“If you think you’ll simply sit back and cash rent checks, you are in for a sad and costly surprise.”

I keep running into the notion on social media, in finance circles, and among the populace in general that residential investment real estate is a good source of passive income. While the stock market has bulls, real estate has a legion of enthusiastic fans. You know who I don’t hear this notion from? 

Actual Landlords.

I’ve talked to exactly zero landlords that think what they do is passive in any sense. I’ve been a residential real estate investor twice in my life and I’ve got to report that I didn’t exactly find it passive either. While the picture painted is one where you buy property, find a tenant, and simply sit back and cash checks. The reality is much different. 

Social media is full of folks cheerleading for residential real estate investing. People tell very compelling stories of how great it is to be a landlord. Others offer classes or systems or even promote that you invest in their deals directly. A major selling point is that you can borrow nearly all of the purchase price and require little to nothing out of your pocket to start. Another common story is that once you place a tenant, you refinance and pull all of your money out to find the next deal and do it all over again. Others tout that you can outsource all of the messy stuff- clogged toilets, bad tenants, and late-night calls onto a property manager leaving you collecting rent in a life of leisure.

Like most things in life, caveat emptor (BUYER BEWARE) applies in spades.

Let’s say you want to enter the real estate game. You have to find a suitable property that will cash flow. In today’s market that’s a pretty tall order. In most areas of the country, real estate prices are considerable and rents are less so. 

A quick “rule of thumb” is that a property has to rent for 1% of the purchase price plus repairs in order to produce any hope of positive cash flow. Less than that and it will hemorrhage cash like a severed artery. Finding 1% property is a tall order under today’s asset prices. I’ve recently looked at two properties that were renting under 1% and both needed at least 10% of the listing price in repairs right out of the gate. Under current returns, I could do better sticking my cash in CDs and getting a part time gig as a Wal Mart greeter.

In short, you’ll have to scour the earth far and wide to find deals that have enough meat on the bone to be worth your hassle. You’ll also have to compete with others looking for the same deal. One experienced investor reports that he gets one deal for every one hundred offers he makes. That’s not passive. 

Let’s say you find a property that works financially. You’ve got to actually make the deal, arrange financing, perform inspections, close at the bank, make repairs, advertise, screen tenants, and lease it. Before you collect the first rent check, you’ve done quite a lot of leg work for months. Even if you outsource the repairs and the leasing, you’re still managing contractors, a banker, and a real estate agent.  That’s not passive.

Once your tenant is in place, you’ll need to collect the rent and periodically inspect the property. You’ll also need to perform maintenance since every tenant is going to break something and even in the long odds they don’t; the grass will still need to be mowed or the snow removed or the exterminator called. Buildings are durable, but they do need constant care and upkeep to maintain their value and habitable status. That’s not passive either.

You could decide to outsource a lot of that to a property manager. Of course, you’ll have to manage the property manager as well. Most will charge 10% of the rent to collect it and arrange for the repair folks that will come from your end of the deal. There will be tenant turnover, perhaps even evictions eating into your cash flow. Your slim margins got slimmer and while your property manager will handle a lot of the day to day, you’ll still have to make decisions and do your due diligence. You’ll need to make sure the property manager is looking after your interests. Decidedly not passive. 

Despite all of that, I think residential real estate can make a great investment and a way to build wealth. But you can’t think of it as “passive” in any real sense of the word. Having a small portfolio of residential real estate is best thought of as a part time job in addition to your other full-time job. A larger portfolio done right is a full-time job on its own. 

I think residential real estate offers excellent potential for small time investors, particularly middle-class folks who have the skills and DIY mentality to manage their own properties, make the majority of their own repairs and perform their own maintenance. My last property had my wife and I collecting rents, repairing the boiler, mowing the lawn, fixing the toilet, cleaning the windows, and hours upon hours running the snowblower. We made an excellent return on our investment but we had to put in the work to get it. 

If you think you’ll simply sit back and cash rent checks, you are in for a sad and costly surprise.

Alternatively, another form of owning real estate is through a REIT, a real estate investment trust. It’s essentially a company that owns and manages real estate and distributes the profits to its shareholders. You buy shares just like any other stock. While my REITs haven’t seen returns like I received on my personally held real estate, my only activity is opening the statements and cashing the checks. 

And that, is truly passive.