We all know real estate investing is a good way to create wealth… but why exactly?
The answer: passive income. Real estate is such a powerful tool, because when we invest, we use capital to generate passive income. Maybe you’ve heard the word “leverage”?
Do you really get how it really works? How is investing different from working a job?
Let’s find out!
Do you have a J.O.B. ?
We first need to distinguish between passive and active income.
If you have a job, your income can be calculated with the following equation:
Number of hours worked x Hourly rate = Income
See the problem here?
There are only two ways to increase your wealth.
- Work more hours. For obvious reasons this isn’t a good idea, especially if your quality of life matters to you. Even if you overwork yourself, you only have a finite number of hours. Your time is the upper limit on how much you can make.
- Increase your hourly rate. This strategy may work if you put time into educating yourself or running after promotions, but sooner of later your industry will place a cap on the value of your time. Promotions aren’t a silver bullet either. They often come with more responsibility, more stress, and more hours, and there may come a time when getting promoted becomes a law of diminishing returns.
You need to find a way to unhook your income from your time and your hourly rate.
Professionals & Salespeople
So, you’re a professional – an accountant or lawyer maybe – and you think I’m not talking to you.
You don’t escape this problem just because you have a high hourly rate and no boss. Your income is still limited by the number of billable hours you have to sell.
Want more money?
You have the same options as an employee: raise your rate or work more. Either your clients will eventually balk at your fees or you’ll get too tired and overworked. It’s the same issue served with a different sauce.
Real estate agents, independent brokers and salespeople of all kinds – you’re in trouble too! While the money you make for an individual transaction may be high, your income still depends on the man-hours you have to create money.
Your income will be limited by the hours you have to put into generating business.
What is it? Why is it so good?
Passive income happens when you own a system that doesn’t obey the equation of hours x hourly rate = income. Think business ownership, stocks or real estate investments.
Passive income systems generate money whether you get out of bed or not. This is why creating or buying a system for producing passive income is the key to building wealth and to gaining control of your time.
Passive income is the means to escape the trap of selling your hours.
How do we create passive income?
We create passive income with leverage.
In real estate investing, you use capital (a down-payment) to set up a system that generates income with other people’s money and the market. Tenants pay the rent. You property appreciates. All this happens without you having to get out of bed.
Real estate investors also – perhaps without knowing it – leverage knowledge and social capital. Investors have networks that help find deals. The professionals, advisors, and contractors they work with help make good decisions, which end up making them more money. Knowledge about the property- and rental markets, tenancy laws, and so on can be leveraged to increase the profitability by making smarter and smarter moves.
This is another kind of leverage.
Of course leverage isn’t only to be found in the real estate sector. It’s a property of how businesses work. Business owners leverage specialized knowledge and human resources (other people’s time) to create income generation systems.
You’ll probably do this too when you become a landlord. Think of the concierge’s hourly rate versus yours. If his hours cost less than yours, you’re leveraging human capital to make more money.
Leverage is a powerful tool, because it allows you to move away from selling your time.
You can learn to use different kinds of capital – social, financial, and cultural – to create systems that provide return on investment in a way that is basically not tied to the amount of time you work.
This is how leverage and passive income fit together.
Should I Quit My Job?
“I understand passive income, should I tell the boss to take a hike?”
Not so fast!
Building passive income systems takes time. If you start investing today, it’ll likely be years before your passive income begins to exceed what you earn at your job. Real estate – like investing in stocks or starting a business – is a long game.
So, should you tell the boss to bite it today?
Probably not yet!
Should you start building a passive income system that will free you from selling your time?
Absolutely! Start right now!
And if you’re not sure how, pick a passive income vehicle (real estate, stocks, business) and educate yourself until you know how. Otherwise, you’ll be trapped selling your time for the rest of your productive life.