In most cases, being active renders the best results. Learn why choosing the passive approach creates successful investors in business and real estate.
Hi. J Massey with CAshFlowDiary.com with another quick tip about real state and business.
Today we're going to talk about one of my most favorite subjects, passive income.
What is passive income anyway?
A very simple definition as many of us know is there are many other forms of income as well. We've also heard of active income. You also have heard possibly of portfolio income. A lot of these definitions come from revenue code but what is passive income? Passive income is just that income, think of it very simply.
It doesn't mean that you are uninvolved in the generation or the creation of it but it does mean that you don't have to literally do something all the time to create it or make it happen.
So, you are more passive in its creation than you are actually active. Most of us are very, very familiar with active income. When it comes to active income, this is when we get up, we go to our jobs. We go
to work. We do something, where we're paid one time for it and it's done.
Portfolio income typically requires using more capital or cash to go out there to create something, usually
a stock they'll pay some dividends or things of that nature. That's what we're talking about portfolio income. Passive income usually means that we've bundled our labor in such a way that now we don't have to labor every day for it but we've sold our labor, we've sold our intellectual property or ingenuity out into the marketplace and it continues to come back to us in this small streams of income over time.
Here's some quick Math that I want to share with you.
Let's pretend that what you wanted to do, because this will teach you the power of passive income right here. Let's pretend that right now, at your job, what you earn is $2000 a month. So if you earn $2000 a month, 12 months in a year, therefore $24000 is what you earn over the course of the year. But
that's active income.
How many hours do you typically work, at least, in the US to get to $24000 in a year? On the average, you're going to work 160 hours on a month and you're going to multiply that by 12 and that's 1920 hours.
So you're going to invest 1920 hours for $24000. Obviously in this example, I am not talking about taxes and all those other things right now. Right now, I'm just trying to give you an example of passive income.
Here's one thing.
What would it take, before I give you an example of passive income because this is active?
So, now, I am going to talk about portfolio. Portfolio income is the income that tends to happen usually use a whole bunch of cash, you stick it somewhere and it pays you interest in dividends over time. So, for the sake of this example, let's use a bank CD so that you can have an understanding of what it would take that same bank cd to be able to produce $24000 annually. So here's what we're going to do. We want to end up with $24,000. That's what we want. What we don't know is how much money we have to have in the bank at an interest rate of 2%. Let's say the bank is willing to pay us 2 %. What I want to know is how much money I have to have in the bank right now, today, to be able to earn $24,000 a year.
The math is relatively simple. All we're going to do is take $24000 divided by 2% and we're going to come up with a number. That gives us $1,200,000. Well here's the good news. All you have to do is earn 1.2 million dollars, stake it in the bank, don't touch it, find a bank that will give you 2% and then you will be able to live on $24000 on a yearly basis.
Now, again we're not yet talking about taxes and all those other things but again, this is portfolio income. Here's one of the things that I absolutely enjoy about real estate, particularly apartment buildings because that's one of the things that I like to do. Is it possible for an apartment building to be able to produce $2000 a month? Obviously, the answer is yes.
So, let's look at it. What kind of apartment building would that be? Let's keep it simple, like a simple
goal is that I like to try to net $100/door/month is a simple target to try to hit. So if I wanted $2000 per month that would typically mean I'm looking for a 20 unit building and after all the expenses, I want $2000 to come in.
Here's the good news about real estate. Depending on the market you're in, what does a 20 unit building cost? For some people, a 20 unit building may only be somewhere in the neighborhood of $400,000 or less. Now for some of you, if you're out in California, that same building could easily be $2M depending on where it's located.
Now here's the fun and power of passive income. First, here, you've got to spend 1920 hours to get $24000 of active income. Here, you've got to earn 1.2M dollars because it's easy to say that that's going to take you more than probably 1920 hours to do.
The question is this: what would it take – let's use the expensive side, let's say that the property is $2M but what you want it to do is be able to control it so that it would produce $2000 a month. When you go to buy real estate – and this is one of the big things that I love about real estate is being able to use leverage, also known as OPM.
Here's the point.
That $2M property in some cases, it is possible for you to be able to only put 20 % down to keep the Math and things simple for myself so that in this case, what you have to do is you take the $2M times 20% and you come up with a number that's $400,000 as the down payment.
Now, I'm going to exclude escrow fees. This is just a simple illustration because I want to show you the power of passive income. This $400,000 is representative of the down payment. So what happens here is that the $400,000 is what was invested and what you come out with on the other end is $24,000 from the income.
That $24,000 over the $400,000 is going to give us yet a new ratio of 6%. That 6% is cash on cash return which is kind of nice, something to think about in this particular case is what if that $400,000 come from, for some time, because in real estate it's very possible that even that $400,000 didn't come from you. And if it didn't, that's great. Sometimes, it is possible to be able to use that $400,000 in very creative ways and more importantly as the cellar for the $400,000 which then creates a completely different situation.
But here's the point. How many hours does it take to put this together? Is it less than 1920? Is it less than the time it takes you to earn $1.2M? I think that you understand that the answer is yes. Let's just assume it takes an entire month, or even 2 months to put this together. What does that now mean? That same $24,000? And if you work for 5 hours a week for 2 months straight, that same $24,000 you did in 320 hours that would come out to $75 per hour, which isn't so bad. And that's assuming you put in the $400,000 and more importantly, it actually took you that long to put the deal together. In like cases, it doesn't take that long.
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