Buying a Rental Property for Passive Income? Here’s Why It Might Backfire on You

If you’re looking for a way to boost your income each month, you have options. You could go out, work a side hustle, and bank the money you earn. Or, you could invest your money and set yourself up with a passive income stream.

One option you may be considering is buying a rental property. While buying a rental property could require a fair amount of money, if you have it available, you could enjoy a steady stream of rent payments from tenants that pad your savings account quite nicely.

But you might encounter several pitfalls if you decide to invest in a rental property. So before you land on that decision, you may want to consider an alternative.

Is rental property really passive income?

Passive income, in the classic sense, is income you earn without having to do any work. You could argue that owning a rental property is passive income in that you’re not working a preset schedule as a landlord. Rather, you’re dealing with issues and tasks as they come up. And during periods when things run smoothly, you’re collecting rent without any hassle. That’s a definite win. 

But being a landlord isn’t exactly easy. Not only do you have to address problems like repairs, but you have to make sure your property is maintained and your tenants are paying rent on time. You also have to deal with filling vacancies when a tenant moves out. 

Granted, these are tasks you can outsource to a property manager so you don’t have to deal with them yourself. But in that case, you risk losing a lot of your profits to a property manager’s fee. 

If you’re planning to oversee a rental property yourself, you may find that it’s anything but “passive.” It may, in fact, be more work than you bargained for.

You could face a host of expenses

You’ll clearly have to plunk down some money to buy a rental property in the first place. But beyond that initial expense, you might face others that eat into your profits. 

First, there are expected expenses like insurance, property taxes, and maintenance. You might also face costly repairs that, in some cases, make it so you’re not earning a dime in a given year. That’s a risk to consider carefully.

Look at true passive income instead

There are benefits to owning a rental property. Not only can you collect income from it each month, but if your property gains value over time, you can sell it and pocket even more money. Plus, owning a home gives you options. If you decide to sell your current home and occupy that space instead, you can do so as soon as your most recently signed lease runs out.

But if you’d rather generate income in a truly passive way — one that doesn’t require work on your part — then you may want to look at investing your money in stocks instead of using it to buy a rental property. Though stocks carry risk, as we just discussed, so does owning a home you rent out. Only with stocks, there’s not much work beyond the initial research you need to do before adding shares of a given company to your portfolio.

And you don’t even have to do a ton of research on stocks if that’s not your jam. If you load up on shares of an S&P 500 ETF (exchange-traded fund), you don’t have to research different companies individually. An S&P 500 ETF gives you exposure to the broad market and offers the benefit of instant diversification. 

Another way to invest in real estate

If you are willing to research stocks individually, REITs or real estate investment trusts are a good way to make money from real estate without owning a rental property. REITs are companies that maintain portfolios of properties, and they make money by leasing out space. 

The nice thing about REITS is that they’re required to pay out at least 90% of their taxable income as dividends. So you might end up with a steady stream of fairly predictable income, similar to how a rental property might pay you a preset amount each month. And you can trade REITs like regular stocks by buying or selling shares in your brokerage account.

A rental property you own could be a source of ongoing income. But it’s not necessarily passive income — or at least not as passive as you might think. If you’re up for the work and like the benefits involved, then it may be a good choice. Otherwise, think about putting your money into an investment portfolio that truly doesn’t require any hands-on work.