At a high level, investment returns can be grouped into two buckets, growth and income. Growth investments, like stock and private equity – deliver returns through price appreciation over the long term. For example, if an investor buys a stock at $10 and sells it 15 years later for $40, they have experienced significant capital growth. At the other end of the spectrum, income investments deliver returns through periodic distributions, but may not experience as much growth. A diversified portfolio usually contains both.
But, in this article, we are going to review eight ideas for cash flow investments. We will describe what each idea is, why it produces income, and the risks and benefits of allocating capital to it. By the end, the hope is that readers will be able to identify one or two investments that interest them.
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To help narrow down the choices outlined in this article, investors should first think about six things:
- Risk Tolerance: As a general rule, income investments are at the lower end of the risk spectrum, but that doesn’t mean they are risk free. Each investor should consider their own appetite for risk because it impacts the achievable returns. Higher risk equals higher return, but it also means more volatility.
- Time Horizon: The opportunity to earn the most income comes over the long term. But, this often means tying money up for five to ten years. So, investors should consider their own time horizon and choose an investment that is suitable for it.
- Available Capital: Some investments have a large minimum investment requirement ($25,000+) while others can be purchased for a much smaller amounts. Investors should consider the amount of capital available to invest and choose an option that is a good fit for it.
- Annual Return Objectives: Return is closely correlated with risk. Investors who want to achieve a higher return will have to be comfortable with more risk. Investors who have a low risk tolerance will have to be comfortable with lower returns.
- Debt Levels: As a general rule, investors should first focus on reducing their debt levels before dedicating any significant amount of capital to an income producing investment. For example, if they have high levels of credit card or student loan balances, it may be best to focus on reducing these first.
- Emergency Fund: Once debt is paid off, the next step is to create an emergency fund of 3-6 months worth of expenses, which can act as a buffer against any unexpected changes in income. When this account is fully funded, then it is time to invest.
In the list below, there is no one investment that is objectively better than another one. But, there are options that will be more suitable based on the factors described above.
Idea #1: Private Equity Real Estate
Private equity firms invest in the privately held equity of other companies, including those that own real estate. In a typical deal, a private equity firm does all of the hard work of finding, underwriting, financing, and managing a commercial real estate asset. Investors who partner with private equity firms provide capital and receive periodic distributions. They have no day to day role in the management of the property.
Private equity real estate produces income because tenants pay rent to occupy a space. That rental income, less operating expenses and debt service provides for a certain amount of money that is available to be distributed to investors, usually quarterly. If the performance of the property is strong, these distributions can be significant, which provide a strong return on investment.
Aside from the income produced, there are other notable benefits of a private equity commercial real estate investment. They include: potential price appreciation, tax deductions, and inflation protection.
Potential downsides of a private equity real estate investment include fees, market risk, and illiquidity. For these reasons, they are typically a good fit for investors with a significant amount of investable capital and a long term time horizon.
Idea #2: REITs
Real Estate Investment Trusts – REITs – are companies who own, manage, or finance commercial real estate assets. For the purposes of this article, we will focus on publicly traded REITs, which allow investors to purchase individual shares of diversified real estate investment portfolios in publicly traded markets. Because REITs tend to focus on specific rental property asset classes – multifamily, industrial, office, retail, etc – investors can usually find an option that suits their individual investment strategy.
REITs have a tax advantaged structure that requires them to pay out a high percentage of the income they earn, which provides a potential passive income stream for investors. For example, Avalon Bay Communities, a multifamily REIT, has a dividend yield of 6.36% at the time of writing, which provides investors with a 6.3% return on capital annually, before any share price appreciation.
Again, the major benefit of a REIT investment is the income, which makes it one of the most common passive income ideas. But, REITs can also provide significant tax benefits and offer the chance for capital gains when their share price rises.
But, the downside is that REIT investors don’t really have any say in which properties their capital is used to purchase. In addition, their share price can be subject to swings in the stock market that don’t reflect the fundamentals of the underlying real estate portfolio.
Idea #3: Real Estate Crowdfunding
In a crowdfunded real estate investment, many individuals come together to fund the purchase of a commercial property. Usually, the group or “syndicate” is formed through a technology platform like Fundrise.
Like other types of real estate investments, crowdfunding produces income derived from the rents paid by property tenants. Investor distributions are paid in proportion to their share of ownership.
Aside from the income, benefits of a crowdfunded investment include the chance for capital gains, tax advantages, and the ability for investors to choose exactly what property they want to invest in.
The downside of a crowdfunded real estate investment is that they can have high fees, long holding periods, and investors have no say in the day to day management of the property.
Idea #4: Farmland Investing
Farmland investing is exactly what it sounds like. Investors can purchase land that is designed for the production of staple crops like corn, wheat, or soybeans.
Farmland can produce income in two ways. First, the owner can lease the land to an operator, who pays rent for the privilege of being able to farm it. Or, owners can work the land themselves and income is derived from the sale of crops.
Aside from income, farmland can produce favorable tax benefits, high levels of price appreciation, and the stability of demand because there is always a need for food.
But, farmland can also be subject to weather related disruptions – like tornados or droughts – and to the volatile swings of price movements for crops. For this reason, income levels can swing from one growing season to the next.
Idea #5: Direct Real Estate
In a direct real estate purchase, one investor (or multiple investors) purchase a property directly. In doing so, they are able to generate income from the rents charged to tenants.
The benefits of a direct real estate purchase is that the investor/owner has complete control over a property’s selection, underwriting, and management. In addition, they get to reap all of the monthly income that it produces.
The downside of a direct real estate purchase is that commercial property is expensive and may only be affordable to the most well funded individual investors. Even then, the amount of capital required may limit opportunities for diversification. In addition, individual owner(s) must bear all of the responsibility of managing the property, which can be incredibly time consuming and requires operational expertise.
Idea #6: Peer to Peer Lending
In a peer to peer lending (P2P Lending) scenario, investors/lenders lend money directly to borrowers who need it. Often this type of transaction is facilitated by a technology platform such as LendingClub or Prosper, which brings together those with money to lend and those who need to borrow it.
Peer to peer lending produces income from the monthly loan payments, which can vary based on the size of the loan, amount contributed, and the interest rate in the deal.
The major benefit of a peer to peer lending strategy is the regular, monthly payments received by investors.
But, peer to peer lenders also face the risk of borrower default. In addition, these loans are usually unsecured so, if a borrower does default, there is limited recourse.
Idea #7: Dividend Paying Stocks
When a publicly traded company is young and growing, they usually take their profits and reinvest them back into new, profitable projects. But, as a company matures, their growth tends to slow and they may elect to return capital to shareholders in the form of dividends. For example, Ford Motor Corp. has a relatively high dividend yield of 2.28% at the time of writing. This is the equivalent of 40 cents per share, per year.
Dividend stocks produce passive income from the dividends paid. Using the Ford example above, an investor with 1,000 shares of Ford stock would earn $400 per year in dividend income.
Aside from the income, the major benefit of dividend paying stocks is that they also have a chance for a strong capital gain – Ford’s share price alone rose 140% in 2021. In addition, the companies that pay dividends are usually well established, which lowers the risk of bankruptcy.
The downside of dividend stocks is that their prices can be volatile and there is a risk that bad business decisions can force companies to conserve capital in the form of cutting (or eliminating) dividends. Historically, this is quite negative for share prices.
Idea #8: Bonds and Index Funds
A bond is a debt instrument issued by companies or governments who need capital to fund some sort of project or investment. They can be purchased individually or through bond index funds and/or mutual funds.
Since a bond is like a loan, they produce income through monthly payments and the return of principal upon maturity.
The main benefit of a bond is their relative safety (as compared to stocks) because debt holders have a priority repayment position.
But, bonds do not appreciate significantly and changes in interest rates can hurt their value.
Even More Ideas
The above ideas are all tried and true methods of producing income. But, they aren’t the only ways. A few more, creative ideas for income generation and/or side hustles are listed below:
- Certificates of Deposit, Money Market, & High Yield Savings Accounts: All of these instruments can be originated through traditional retail banks and they produce income because investors are paid interest when they allocate or deposit money into these bank accounts.
- Sharing: The modern sharing economy has allowed individuals to monetize things that they may already own. For example, they could rent an extra room in their house on Airbnb or rent their car on Turo. Both of these options can be a great way to earn some extra cash or generate streams of income from things already owned.
- Content Creation: Creating content is quickly becoming a big business and a way to generate income and build wealth. For example, bloggers can earn income from clicks, experts can create an online course on a platform like Udemy, entertainers can create a podcast or youtube channel, or expert marketers can utilize social media to produce a return on their investment.
- Affiliate Marketing: Individuals who can build an audience can earn income through an affiliate marketing program by driving traffic to websites like Amazon and earning a small commission on products purchased.
- Sell Stuff: There are a number of online platforms that allow individuals to sell stuff that they create or buy. For example, creators can sell their products on Etsy or individuals can start their own small business by selling stuff through well placed vending machines. Both require a small upfront investment, but may be a good source of passive income over the long term.
In the modern economy, there are no shortages of ways to generate income. It just takes a bit of creativity, dedication, and some luck. When individuals find success, the income can go a long way towards helping achieve their financial goals.
Interested In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. With an intentional focus on finding world-class, multi-tenanted assets well below intrinsic value, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
If you are an Accredited Real Estate Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or firstname.lastname@example.org for more information.