passive streams of income

Do you think making passive streams of income in real estate takes a lot of money?

Here’s some good news. Many investors felt that way, and so they created a nifty little investment called the REIT (Real Estate Investment Trust).  This way the little guy could start getting the type of portfolio exposure that real estate offers without having an extra $500K in the bank. Getting passive streams of income shouldn’t cost that much to start up.

 

When most investors think of investing for passive income, they think CDs (Certificates of Death), Bonds (Currently at record low yields), or dividend paying stocks.  I already gave you hints as to why I don’t bother with CDs or bonds.  Dividend paying stocks can great investments as well if the underlying company has strong financials likely to keep it growing.  But when it comes to investing for pure cash flow from the comfort of your computer chair, REITs take the prize. Here’s why…..

passive streams of income

Taxes, Taxes, Taxes….

If you invest in a stock that pays a dividend, Uncle Sam gets real greedy about it.  Not only do they want their piece of the pie when the money is first earned as income, but also when we as investors receive it as income on the personal side. In other words, not only must that income get taxed at the current corporate rate (which right now is at 35%).  They also tax it again according to your income bracket once received as a dividend. Investing this way will not give you wonderful passive streams of income. Seems pretty rough for somebody who only owns a couple of shares of IBM huh?

 

But REITs get treated a lot nicer.  Because they are trusts, and are expected to pay out the majority of the earnings that aren’t reinvested, the income allocated towards dividends isn’t taxed at all on the business side.  Since the trust has to unload the majority of its capital, and since they have to pay less in taxes, you tend to see much, MUCH higher yields on many of these investments.  Sometimes yields exceeding 10%. A much better way of gaining passive streams of income.

 

Wait, it gets better…..

If that’s not great enough, there are actually ways to get your ROI even higher.  The concept behind investing for cash flow investing is that you want to get your money back off the table.  The moment you do, your risk is reduced to zero, and you essentially own a cash flow asset for free.  The concept is called Cost-Basis Reduction, and it lets us measure how attractive an investment is based on how long it takes to get paid back on our investment.

 

The first way to maximize your cost basis reduction is to simply find a higher paying dividend.  Looking for an REIT that pays out 7% or even 10% makes a lot more sense than taking a 4% yield, providing the underlying financial condition of the security is stable.

 

This leads us into our next way to maximize cost basis reduction.  BUY THEM ON SALE.  The actual monetary amount of the dividend tends not vary throughout the year.  In other words, whether the REIT is at $80.00 per share, or $60.00 per share, the dividend will be $6.00.  So why would you buy an asset that pays $6.00 for $80.00 if you knew you could buy it for $60.00.  Becoming competent at recognizing market trends can help you identify if the current price of an REIT is likely to drop.  The cheaper you can buy the REIT, the higher your yield, and the sooner you can take your money off the table. You’ll get bigger passive streams of income.

 

Heads I Win, Tails You Lose…

Let’s take “Buying on sale” one step further.  Did you can put on a fixed offer for a stock, or even an REIT, just like you do a house?  The stock market has contracts just like real estate does.  They call them options.  And here is the beautiful thing…..they will pay you to put in your offer.  Normally you have to put money down when you put an offer on a house into a contract.  But with stocks and REITs, you can get paid a premium to put your offer in.

 

Here’s how it works.  Options selling is basically your way of writing an offer in contract, committing to buying or selling a security at a fixed price.  In particular, when you sell a PUT option, you are putting an offer in to only buy the security if it comes below your agreed price.  And they pay you a premium.

 

Here would be the ideal scenario.  You find an REIT that’s selling for $120.00 and pays a $10 dividend.  You want to buy it at $100.00.  So you sell a put and receive a $5.00 premium.  If the price of the REIT drops to $100.00 or below, you purchase at $100.00.  And since you were paid a $5.00 premium, you are actually paying $95.00 to acquire the security.  $10.00 dividends paid on a $95.00 acquisition is a 10.53% yield.  If you bought it at the $120.00 price, your yield would have only been 8.33%

 

But let’s say you didn’t get the offer through by the time it expired.  GREAT!  You still keep the $5.00 and you can sell ANOTHER put to receive another $5.00!  Now if you get assigned the next time around, you effectively acquire the same security for only $90.00.  That ups your yield to 11.1%

 

So it’s heads I win, tails you lose.  Either you keep racking up premium making your eventual acquisition price cheaper. Or you simply get paid to buy the REIT on sale.  Either way it’s creating more and more cost basis reduction. Resulting to nicer passive streams of income.

 

Paying Less In Taxes IS Smart…..

If you aren’t already getting excited over this, here’s one more edge you can start using.  You might want to consider purchasing REITs in a ROTH IRA.  Roth IRAs are pretty cool because you contribute with post tax money.  No advantage on the front end.  BUT, that money can grow as large as possible, and it can’t be taxed upon distribution. A nice way of getting passive streams of income. You paid on the front end so you can grow it and grow without worrying about tax on the back end…..

 

This means that not only could you use options to receive premium that won’t be taxed, and purchase an REIT on sale.  But when you start receiving those big dividends, they are exempt from tax both on the corporate side AND the personal side.  You can’t do any better than that!

 

So the bottom line is…….if you are going to be investing for cash flow, consider how to create cost basis reduction, and get strategic with your taxes.

 

If you need any help with applying this strategy, or other effective investment strategies, feel free to subscribe for free investment strategies here.

 

About The Author

herbertkoehler

I am a college drop out who found my passion as an investor. I love the many facets of finance, investing, and business. But even more than that, I love sharing what I learn with others.

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