I was getting ready to write my monthly passive income report and took a little look into our equity investments and real estate investments. I wanted to figure out whether selling our investment property and investing the money in the stock market was the right move. It’s the classic stocks vs. real estate question.
I calculate each number very different than anyone else on the planet (too my knowledge). To calculate equity income, I simply take 2.5% of our total amount invested. That’s what we could safely earn in dividends if we wanted to move our money for that goal. In reality, we invest differently, but the 2.5% number may still be accurate. Much of our US stock investments are in a high-dividend ETF (HDV) paying a 3.83% yield.
To calculate real estate income, I require you to take a mental leap. We chose short mortgages to get to our goal quickly, but that means we don’t make real dollars now. We’re getting equity a lot faster, so it’s still the right move, but it doesn’t give us spendable income right now. You can imagine that we could sell the property and use the equity to buy a new one that is owned completely by us with no mortgage. That property could be rented out (at a lower monthly rate) and it would make us income.
Here’s another way to think of it. If you and your sister each owned half a rental property, you’d split the profits after the expenses, right? In our case, our sister is the bank. We have 75% of the equity, so we should get 75% of the profits. I calculate our rental income number as the profit (rent minus expenses) multiplied by the percentage of equity we own. For example, if we have a property that rents for $2500/mo., but requires $500/mo. of expenses it is a $2000 profit. Since we own only 75%, I count it as $1500/mo. in income. This gives us a fair value for our equity.
It works very well. I recommend all real estate investors give it a try.
This gives me two numbers that I can use for comparison. Since 2017, I’ve been directly comparing the numbers. I’ve also been adding them together to come up with a “passive-ish” income. However, “passive-ish” never felt right to me. It’s not fair to compare something that is completely passive like dividends to something that is only passive sometimes like rental income.
When we sold a rental property at the end of July this passive-ish number took a nosedive. We couldn’t expect to make as much rental income. We converted that reality estate equity to stocks and used our 2.5% estimate. It was still looking like a big loss in passive-ish income.
That didn’t feel right – the income is now more passive. Since rental income isn’t 100% passive, maybe I should have only counted a portion of that income as passive all along. So now I consider it only 80% passive income. That 80% isn’t a scientific number, just a guess that is more accurate than my previous math that presumed it was 100% passive income. Another way to think of it, is that we could hire a property manager to make it more passive, but that money creates another expense. That would bring it near to the 80% passive income anyway.
Here’s a graph of both types of passive income. The blue line represents the old way. The red line represents the new way.
You can see the big drop in July in the blue line. It went from $6200 to $5800. Using the new formula, the rental property had less of an effect, so the drop wasn’t as drastic. This method seems more accurate and feels more honest.
I then had another cool thought. We were able to sell at the peak at the market in July. We’ve been able to dollar cost average into a market that is about 25% off its highs. I see the market rebounding to its old highs before real estate goes up another 25%. So maybe the income will not only be more passive, but have more room for growth.
Finally, I wanted to say that I found it important to simply get started with tracking passive income in some way. If you think my way is terrible then use what works for you. I started doing it in 2017 – which was already more than ten years of personal finance blogging. It may start small and it definitely grows slowly, when you are in the moment, but looking back over the last five years it’s amazing how much it’s grown.