Welcome to the fourth part of this series on the 3 types of income one can get through real estate investing. This is actually part 2 the third type of income which is passive income. Before you begin reading this article, I recommend you review the first three parts:
In the first part about passive income, we defined what passive income is, showed some examples of it, listed down advantages and disadvantages, and some key points we should remember about it. Now let’s continue…
Before I talk about how passive income from real estate can lead to financial freedom, let me first try to define what financial freedom is for me.
What is financial freedom?
For me, financial freedom is having the freedom to do the things that are truly most important in life for you, the things that you really want to do, not the things you have to do, the things that you would do if you had a choice, and you can do all of these without worrying about where to get money to provide for your family, because there is more than enough cashflow in the form of passive income that can sustain all of your needs, without the need for job or a life where you are stuck in the rat race.
More importantly, financial freedom also means having time freedom, and if you think about it, time is really the most precious commodity we have. Once it passes, it cannot be brought back, and it is gone forever. I’m sure most of you out there would agree that when you are stuck in the rat race, there is no such thing as time freedom.
What is the “rat race”?
Just what is the rat race? Wikipedia defines the rat race as an endless, self-defeating or pointless pursuit, often used to describe work, particularly excessive work; in general terms, if one works too much, when one is in the rat race. Most often in the rat race, one can expend a lot of time and effort, but ultimately achieve nothing meaningful.
Another way of looking at it would be to realize that living life in the rat race becomes pointless if it becomes detrimental to your family, relationships, health, and to your life in general. What’s your rat race?
How much passive income do we need to be financially free?
Okay, so how much passive income does one need to get out of the rat race. The answer is simple, it should be more than enough to cover one’s monthly expenses.
Going back to our previous assumption that we need to earn at least Php100,000 per month to cover our monthly expenses (and also have enough for our other “money jars“), how many passive income deals like our previous example do we need? The number of deals would be equal to our monthly expenses divided by the monthly positive cashflow from passive income which we computed as Php4,057.41/month
Number of passive income deals = Php100,000 per month / Php4,057.41 per month
=24.6 deals or 25
You might be saying “What the… it would take that many deals just to get out of the rat race?!“.
But don’t forget that if you focused on flipping, even if you made 25 deals already that each made Php100,000, you will still have to continue flipping properties, and it would be an endless cycle, much like that in the rat race.
If you focused on true cashflow generating properties, and even if each only made a measly Php4,057.41 of positive cashflow per month, your 25th deal can be your last because you already have accumulated more than Php100,000 of positive cashflow from passive income! You can stop and retire if you wanted to because you are already financially free!
Getting out of the rat race faster
I know I know, a lot of you out there might still be saying “I need to buy 25 rental properties just to get out of the rat race?! That could take forever!”.
But there are ways to get out of the rat race faster, let me show you a couple of examples:
1. Instead of rentals, go for a rent-to-own scheme
What if you bought a foreclosed property for Php1Million by putting down 20% downpayment or Php200,000, with a remaining loan principal balance of 80% or Php800,000, let’s assume the balance is payable in 10 years at 12% annual interest rate(this is the current rate for most banks).
This results in a monthly amortization of Php11,477.68/month( You can verify this by using our mortgage calculator). You will notice this is even higher than our previous example.
This time however, instead of renting out the property, what if you sold it through a rent-to-own scheme at a contract price of Php2M @ with 10% down with the balance payable in 15 years at 15% annual interest rates? Your tenant-buyer would then be paying you Php25,192.57/month for the next 15 years.
Assuming monthly expenses all add up to about Php4,000/month just like ion our previous example, the resulting monthly positive cashflow would be:
Monthly Cashflow = Monthly Rent-to-own payment – Monthly Expenses – Monthly amortization
=Php25,192.57 – Php4,000 – Php11,477.68
How many passive income deals like this do we need to get out of the rat race?
Number of passive income deals = Php100,000/month / Php9,714.89/month per deal
=10.29 or 11 deals
Wow, from 25 deals down to 11 deals, now this is more like it! But wait, there’s more! What if you and your tenant-buyer agree to shorten the payment period?
2. Shorten the payment period
What if instead of having a rent-to-own agreement that has a payment term of 15 years, you go for 10 years instead? Your tenant-buyer would then be paying you Php29,040.29/month for the next 10 years. The resulting monthly cashflow would be
Monthly Cashflow = Monthly rent-to-own payment – Monthly Expenses – Monthly amortization
= Php29,040.29 – Php4,000 – Php11,477.68
How many passive income deals like this do we need to get out of the rat race?
Number of passive income deals = Php100,000/month / Php13,562.62/month per deal
=7.4 or 8 deals
Wow, from 25 deals down to 8 deals! Actually there are a lot more things one can do to get out of the rat race faster. One way is by increasing the net monthly cashflow by lowering maintenance/property management expenses. another way would be to refinance your loan with another bank at lower interest rates, etc.
I won’t discuss them here for now, I would not want to get anyone out there to become overly optimistic and want to get rich quick. Keep in mind that investing for passive income is not a get rich quick scheme!
Again, we also need to consider that for rental income, taxes range from a low of 3% percentage tax to a high of 12% VAT, which are mutually exclusive. You pay one or the other, depending on which is applicable. As mentioned previously, the taxable income can be reduced through allowable deductions, thereby lessening the payable taxes. Let’s discuss more about taxation of rental income in a future article.
Another thing about rent-to-own deals, keep in mind that your cashflow stops at the end of the payment term as you no longer own the property. But still, your cash comes in all throughout the duration of the rent-to-own agreement, which is 10 years in my last example above. Anyway, I believe one can “create” a lot of other passive income streams in 10 years time to replace one rent-to-own deal right?
Passive income will help you stop living life passively
One thing I failed to mention in the first part about passive income is it really helps one to stop living passively. When I say living passively, it’s like one is going through life like a zombie who just accepts what’s happening, instead of taking charge of our lives.
For example, one just goes through the motions of being an employee, yet there is more to life than just being an employee. There is a way to live where you don’t need to spend most of your time making a living and you can actually focus on the “living” part. One does not need to live life passively because we always have a choice. Bo Sanchez explains this best in his article “Don’t be a Zombie”
Can it really be done?
Yes, it can really be done, you can trust me on this. The key is persistence, commitment, perseverance, bias for action, the drive to keep moving forward in spite of failure, having courage to face your fears and get out of your comfort zones, and the will to succeed! If you don’t believe it is possible, then you might be surprised when you read this!
Where do I start?
“All this talk about passive income and financial freedom sounds nice but how does one start?” you might be asking.
Most focus on “how”. Just like what most of my mentors and books I’ve read say, I believe you should first focus on “why”.
Why would you want to start this journey to financial freedom?!
That “why” should also be big enough to sustain you and see you through until you succeed!
You need a big enough reason to start, an emotional why, a higher purpose, something worth fighting for. Think about your rat race and why you would want to get out of it. What would you do once you are free? Find that purpose and use it to fan your burning desire and your passion to achieve financial freedom.
If passive income is easy, everyone would be doing it right?
Yes, if it were easy, everyone would be doing it. But I did not say getting passive income is easy, because it’s not. It may sound simple, but it is not easy, and it is probably the hardest of all real estate investing techniques to do, and with good reason. It is harder to find those positive cashflow generating properties than properties that can be flipped for a profit.
But let me tell you something that I have learned through firsthand experience. Sure it may not be easy, but it is definitely easier than most people think! This is coming from someone who is doing it.
I also believe that you can do it too!
Coming up next: Summary and wrap-up on the three types of income one can get through real estate investing
Yes, you read that right, there will be a fifth and last part of this series where I will summarize everything and add some more of my insights (yes, there’s more!), and yours as well, along with any other questions you may have.
Go ahead! Please write them down in the comments section below. Thanks!
To our success and financial freedom!
Real Estate Investor
Real Estate Broker License #: 20056
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Text by Jay Castillo and Cherry Castillo. Copyright © 2010 All rights reserved.
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