Not everyone in this world knows the secret to become wealthy and only a handful will share the how-to.
Traditionally, we are taught that in order to make money, we need to “Work Harder, and work more hours!” While working more frequently may increase your employment income, a person can only spend so much time working at their maximum capacity. If we live to 80 years old, an average person at least spent 26 years working. You might think that there is a huge difference between a Walmart Greeter and a well-established Lawyer, but they both have a time for dollar exchange. If the Walmart Greeter decides to call in sick for the day, they will not earn an income. The same story is true for the Lawyer.
“Rich Dad, Poor Dad” by Robert Kiyosaki states that there are four quadrant of cash flow. Such are Employee, Self-Employed, Business Owner and Investor.
In the example that we have mentioned above, the Walmart Greeter is an Employee and the Lawyer is Self-Employed, whom both trade time for money and pays the highest amount of taxes.
So what about Business Owners and Investors? These two groups are the wealthiest ONE PERCENT of the world population while holding 95% of world’s cash. They do not exchange time for money; they own a system where people and money work hard for them. They are able to achieve this by understanding the importance of passive income.
Passive Income Creates Value
Canadian Revenue Agency says that passive income can only come from two sources: from investments and from businesses. Once you develop an income that is truly passive, it will not matter whether you are working or not, you will still be earning!
You now understand that passive income can allow you to work much less, but how does this create wealth? The answer lies within what you do with that spare time. If you lay back and watch TV all day, then wealth will not find you, but if you use additional time to create another source of passive income, and then another, and still yet another, your income begins to grow exponentially!
This is not a “get rich quick” scheme; not everyone can own a business, but anyone can learn to invest.
To create passive income, we need first to understand the fundamental difference between assets and liabilities. When we invest, we want to focus on creating assets instead of diminishing liabilities. Assets put money in our pocket even if we are not working and liabilities depletes our pocket of value.
“Leverage” — when we use debt to generate passive income to pay debt.
What kind of Investment is Asset?
Real Estate and Stock/Bond that provides a monthly payment as return are assets.
Dividend paying stocks and bonds are hard to select and difficult to control as market fluctuation tend to be much higher with greater frequency. Thus, many of investors choose to invest in real estate for the safety and physical existence of such asset. An investor can invest many ways in real estates. The most direct approach is to purchase a property with high potential rent or capitalization, which requires significant financial backing (down payment).
The most important fact about income property is Capitalization. Cap Rate measures the potential annualized return base on rental income and capital appreciation calculated with cost and inflation in mind. A reasonable cap rate for an income property is between the ranges of 6–8%. Managing such property requires a level of supervision on many variables, such as cost, occupancy rate, inflation, rent growth, tenant relationship and more. To sum up, one has to focus time, effort and dedicated fund in order to acquire enough income properties before it is truly passive.
For beginner investor, people with no large savings or simply no time to manage, other alternative real estate investments are available.
There are two most credited alternative real estate investments on the market, which are REITs (Real Estate Investment Trusts) and MICs (Mortgage Investment Corporations). Both of which are fully regulated investment solutions just like public traded stocks.
REIT operates like a holding corporation with hundreds if not thousands of shareholders. REITs will pool shareholder funds together to purchase multiple and varies type of properties that generate high monthly rent yield. In this model of investment, an investor do not have to invest significant money to obtain a partial ownership of many properties.
On the other hand, there are MICs. Mortgage Investment Corporations operate on the other side of the property transaction, “the mortgage originators”. MICs offer similar to REITs investment limit where the investor do not have to contribute large fund, but still gets the benefit of high real estate returns. The added security comes from the concept of debenture ownership instead of direct ownership. The investors partially owns debts(mortgage rights) on a portfolio of mortgages, which in turn owns the properties if any default were to incur. In addition, because MICs earns return on interests, there is no property management cost nor capital gain tax.
The trade-off between MICs and REITs is the potential capital growth of property value overtime, where REITs are able to capture by liquidating properties on a timely manner. However, to compete, MICs in general have a higher monthly return and shorter investment duration. REITs tend to have less choices as most established REITs have closed their purchase availability. MICs offer the choices of different management and mortgage portfolio held by different corporations.
Effect of Market on Passive Income
We all know that the Real Estate Market is cyclical. The market rise and fall, where most recent example happened in 2008 and 2013. How is this affecting the passive income investment market?
With the current market environment, many have shied away from entering the real estate market due to bad experiences. However, from an investment adviser point of view, this is the best time and opportunity for stepping into the passive income market. With pricing already reduced and less risk to confront, many investment company such as HRU MIC adjusts their risk management to the current market rates and provisions, through calculated models and “Bank Like” practice. Even with further downturn in market value, a more predictable result can be considered and adapted. Therefore, the current market offers an much positive outlook for passive income opportunities.
All in all, most passive income solutions provide a safe and secured investment environment like no others. To truly achieve financial freedom is a long and organized process. Passive income is considered to be the most stable and manageable method.