Awhile ago I wrote an article that explained the difference between active and passive income (See: The Truth About Active Income vs. Passive Income). In it, I talked about which investing methods fall under which income category. I identified having rental properties as being in the passive income category.
Guess what though… there is a hitch I left out. Are you ready? If you own a rental property, it requires management in order for it to produce income. The method of management you choose may change your property from being a passive income investment to being an active income investment.
Options for How to Manage a Rental Property
You have two choices on how to manage your rental property. You can:
- Manage it yourself, i.e. be a landlord
- Hire a property manager.
The difference? If you choose to landlord the property yourself, you force yourself to work in order for the property to continue providing income. Doesn’t that change that income from passive to active? Absolutely! But what impact does that change in designation cause? More than you might think.
The Financial Breakdown
Let’s use one rental property to break this thing down. This one rental property (owned by you) cash flows, after all expenses, $300/month. On average, this property requires five hours per month to maintain properly (some months will require no work towards management and others will require more, so just taking a ballpark here).
Scenario 1: You manage the property yourself. If you manage the property yourself, and you make $300/month doing it, that equates to you getting paid $60/hour for the work that you put in ($300/5hrs). That’s not too bad.
Scenario 2: You hire a property manager (PM). Property manager fees run on average about 10% of the monthly rent collected. We’ll say this property brings in $1,000/month so you have to pay your manager $100/month. Now you cash flow $200/month ($300 – $100 PM fee). You do no work on this property.
The two options can be summarized as:
Scenario 1: five hours’ work per month = $300 income
Scenario 2: zero hours’ work per month = $200 income
You earn $300/month for doing five hours of work or you earn $200/month for doing 0 hours of work. It’s a difference of $100, so for five hours that means a $20/hour difference.
Whoa! Now this changes things. If the difference between working on the property and not working on the property is only $20/hour, that means you are in fact only profiting $20/hour, not $60/hour as suggested when we first looked at scenario #1. You would only be making $60/hour if the alternate, scenario #2 (not landlording), gave you no income. But that’s not the case because not landlording the property yourself does in fact still pay you income.
So now we are looking at $20/hour profit for landlording your own properties. That sounds okay, right? Well it depends on what you would otherwise be doing during those hours that you weren’t working on the property. If you only sit in front of the TV and eat popcorn during those extra five hours per month, then it would behoove you to go ahead and get to landlording because you will make more money doing that.
But if you have another job or other work that you do, if it pays more than $20/hour, then it is actually costing you money to landlord the property. For example, if you make $35/hour in your normal job, it would cost you $15/hour to landlord this property yourself. See the math there? You could earn $20 in an hour by landlording this property or you could make $35 in an hour by working your other job during that time, so you are losing $15/hour during that time being a landlord.
Now check this out. This is where everything gets really crazy. Let’s say you go with scenario #2, using a property manager, and during those five hours that you would have otherwise been landlording, you work your other job instead. That job, remember, pays $35/hour. Remember too that using a property manager on the property provides for $200/month income which breaks down to $40/hour for those five hours you would have had to work. You earn $40/hour from the property and now you decide to spend those now-available five hours working your other job which brings in $35/hour. So now you are making $40/hour plus $35/hour! Wait a minute, so you are actually earning $75/hour by using a property manager? Yes! That is more than the $60/hour had you managed the property yourself and had no other option.
I beg someone to tell me how not using a property manager saves you money.
Ah, okay, a critic. You just thought, “Well what if I don’t work another job during those five hours so I’m not making any extra income? Wouldn’t $20/hour be better than nothing?” Maybe, but it depends on what you would be doing during those hours. For most everyone, I’d imagine that you would use those five hours to spend time with your family, enjoy your hobbies, hang out with friends, or learn something new. Is $20/hour really worth giving those things up and replacing that time with the menial task of landlording? For only $20/hour? You would be taking on headaches and stress every month all to make an extra $100. I know some of us can be stingy, but come on. You can’t tell me that amount is worth it.
So again, I beg someone to tell me how not using a property manager is better, either financially or mentally.
Rental Properties and Lifestyle Design
In active vs. passive income article too, I talked a lot about lifestyle design. The whole point of lifestyle design is to be able to live the life that you want, regardless of what that may be. The whole point of investing in rental properties, whether residential or commercial, is so you can have passive income which allows you to do whatever else it is you want to be doing in life while not having to worry about income.
Who have you ever heard talk about financial freedom in relation to wholesaling or flipping properties? No one, because both of those are based on active income, meaning you have to work in order to reap the profits. If you are working, how can you be doing whatever it is you want to be doing at the same time? You can’t. Now, if rehabbing properties and all that is something you love and would do it as a hobby regardless of the income, then that is a different story.
If a rental property is meant to produce passive income, how exactly does that really happen if you are spending time managing it?You are then working for your income, meaning it is active income, meaning you can’t be doing other things that you would rather be doing. Never mind the fact that this whole example was based off thinking of just one property! Uh, hello, if you own 10 properties you aren’t still only working five hours on all of those. You better be calculating five hours per property! With 10 properties you are looking at 50 hours per month of work. I won’t even start in on that math.
If your goal is to have financial freedom, or maybe even just financial “relief”, you need to understand what that really means.