A YouTube podcast episode (Think Outside the Stocks, ep. 5) in which host Madhavi Jain argues that single-family rental real estate—though labeled passive by US tax code—often behaves as an active, risky investment. The episode lists key risks (affordability and shrinking cash flow post-2022, sensitivity to market cycles and recessions, scalability limits for achieving large passive-income targets, legal/asset-protection exposure, personal-credit risk from loans, and operational burdens summarized as tenant, toilet, and trash). It closes by previewing a follow-up episode about passive commercial real estate syndication.
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Are you frustrated watching your hard earned money ride the knee jerking Wall street roller coaster? Are you looking to diversify into alternate investments and set them on autopilot to achieve financial freedom? It's time to learn the ways of the wealthy. It's time to Think Outside the Stocks with your host Madhvi Jain, an immigrant from India and ex IT professional who will bring you industry experts to illustrate a passive and holistic financial approach to build not just passive income but also your generational we Madvi is on a mission to change the financial trajectory of one family at a time. And a thousand more to go. Are you going to be part of this vision? And now without further ado, here is the host of Think Outside the Stocks, Madhvi Jain.
Hey, hey, hey. Welcome back. Welcome to episode number five with Think Outside the Stocks podcast. And this episode is going to be continuation of our short course, Active Income with Passive Real Estate Investments. So today's module going to be is is rental real estate really passive? So let's jump in. In episode number three, the second module of this course, we looked at different ways of participating in real estate, most of them being active. The busy professionals like you are scared to go into it because of the risk, effort and time sensitivity that you have. Some of you actually may have dwell into the real estate by getting into rental real estate. So you may have one or more rental real estate, a rental real estate portfolio. So is that rental real estate really a passive investment? Well, according to US Tax code it is. It is a passive activity and that's why it provides you passive income and passive losses too. Today let's talk about how the rental real estate is not really a passive income and also talk about multiple risks that it brings to your portfolio, to your financial structure. Risk number one, affordability and drying cash flow. We are in the beginning of 2023 right now and at this point we are looking at the rental real estate. The affordability has become a top concern. The recession, the market fluctuation and how the prices are fluctuating is concerning as well. When it comes to your financial freedom. The scalability in rental real estate can create problems quickly. The fourth risk is the asset protection. Not many landlords consider this. They think that hey, we are not going to have any kind of legal problems. The next risk is when you are creating and going into these loans, you have your personal credit on the line and if something were to happen, if you were to lose this rental property to the market, you are personally liable. And the last part, why this is not a Passive income is the three T's, the tenant, toilet and trash. Let's jump into this risk one by one. Let's take a look at risk number one. Affordability and a drying cash flow. What we saw post 2008 has been a tremendous growth in real estate prices. The expansion in real estate has lasted for the longest cycle in the history. During COVID times we thought we will see the end of this expansion. But on the contrary, there was so much of pressure and the prices even went up. In fact during 2020-2022 it created tremend when it comes to the prices of the single family homes. In fact, between 2020 and the beginning of 2022, there was a tremendous growth in single family home pricing. But now after 2022, the mid part of it and moving into 2023, we are seeing these prices being adjusted. There is still an affordability issue. You cannot get into a rental at a rise price point. And in 2023, with so many interest hikes by the feds, the the mortgage payment, the property tax payment, everything has gone so up that the cash flow has become a problem. If you were to purchase a rental property right now, first of all, it is very hard to find the right property to move into it. The rising interest rates and the prices which are already skyrocketed, they have created this situation of not having sufficient cash flow. So people actually are moving in just with appreciation in mind, which is tremendously risky. This is what happened in 2008, why people lost their rental properties. Because with the market downturn, you can quickly be an upside down in your own property. So if you are thinking of buying a rental real estate and not having enough cash flow, in fact negative cash flow, think twice. Don't move in with just an appreciation in mind. Let's look at the risk number two, the recession and the market cycle impact. When it comes to your rental real estate portfolio, especially the single family homes, they ride the market cycles and these cycles are repeated over the period of time again and again. There is a cycle of recovery from recession. That's when the prices of single family homes start going up. And then there is a cycle of this expansion where single family real estate is looking at that hyper growth and value increase. And then there is a cycle of the hyper supply where there is so much supply in the market that the prices start getting adjusting and falling down. And there comes the recession right after where the prices of single family homes start falling down. We have seen this tremendous impact in 2008 and we have started to See this impact the beginning of 2023 as well. Let's take a look at it from a scalability perspective. If you are to create a financial freedom, suppose you have a particular number in your mind. Say on a very conservative level, you are thinking about creating 10,000 as a passive income cash flow. Say you have a $200 cash flow per rental house. How many rental units do you need to reach to that $10,000 passive income? About 50. Is that even feasible? Think about how much management that you have to do even if you assign a property manager. And hey, you cannot even exceed that 10 portfolio because you have a restriction of only 10 loans per person when it comes to the single family leverage. So unless you have a boatload of money to purchase these houses, cash down scalability towards your financial freedom is one of the top concerns. Let's talk about the legal, that is the asset protection perspective for a minute. Are you a landlord? Do you have a rental property? Do you own it in your own personal name or have you created as a part of llc? And why should you do that? Right? Because creating it as a part of LLC provides you that legal protection. There are several ways that you can get sued or get into legal troubles in this country. There is something called outside liability. Say for example, for example, if you get into an accident and if it is your fault, and if the other party sues you for liability and you have these rental properties in your portfolio, in the legal course, the lawyers are going to be so happy about your rental properties because they have now the direct access in terms of getting that legal action rectified. What about the inside liability? Have you ever thought about that? Something can happen inside the property. Suppose you have a tenant who trips and falls inside the home or outside in the driveway. The person can sue you as a landlord for the liability. And again, all the cash that you have invested, all the equity that you have invested in this property can become a target of this legal lawsuit. So given that it is best to invest in single family rentals inside an llc. But hey, creating this legal structure is extremely complicated and expensive. There's so much hassle that typically landlords, they typically own the rental properties in their own name and hence creating a huge liability, let's talk about the next risk. The loans and your personal credit on the line. If you were to buy a rental property, if you were to buy a rental real estate and you go to a lender for a loan, what do they ask for? They ask for the property details, but they also ask for your personal Finance details. They ask for how much income you're making. They ask about your liquid assets, your stock portfolio, your other properties. They even ask about your 401k. Why do they ask for it? Because now the lender is thinking that in terms of default, is there a recourse for me? So yes, all these liquid assets, the entire financial statements that you provided to the lender that immediately becomes exposed in case of a default and also in case of default, what is going to get impacted is your personal credit. This is the biggest thing that you have on the line. Your credit score is treated as such a golden egg in this country. If that gets impacted due to the default. There are so many different implications, the domino effect of implications that you will have. And lastly, let's take a look at why this rental activity is not really passive, even if the tax code calls it passive. And the reason behind it is the three T's of the landlording, I.e. tenant toilet and trash. There are tremendous amount of activities needed for managing a rental real estate in terms of the tenant turnover, analyzing your tenants, getting that loan and expenses paid when there is no tenant in this property. So managing that vacation can see even if you get a tenant in place, if the house starts creating this massive, massive expensive repairs. I once had a tenant who created such a mess out of our rental property. They literally trashed this home that became a dumpster. We had to pay $5,000 to take their stuff, the garbage, the dumpyard that they had created out of this house, an additional $15,000 to bring this property to its own glory so we could rent it to another tenant. So 20,000 in for a rental real estate that was giving us just about $200 of cash flow. It would have needed hundred months to get break even. So we saw all these reasons and they are so scary, right? So you must be thinking at this point that is real estate even a right choice for me when I am trying to diversify outside of the stock market. But wait, the single family rentals is not the only way of participating in real estate. In fact, there is another way that you can participate in commercial real estate investments in a completely passive way. And these are the strategies that I am talking about which I was mind blown when I found out. That was my aha moment, that hey, I can create this income completely passively in commercial real estate. So in our next episode, episode number six, we will continue our journey and we will unlock this key of passive commercial real estate through the world of syndication. So stay tuned and see you on the other side in episode number six.
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