Passive Income & Real Estate: Is That Possible?
Key Takeaways
- Passive income (from return on rent) is important for many investors when investing in real estate in Germany
- The sad reality is, that is very tough to find properties returning a positive cash flow in this current real estate environment
- If you know how to manage your risk, investing in real estate in Germany with negative cash flow is fine
- Tokenized real estate like our Blockchain-based real estate security tokens offer immediate passive income to investors
Why Passive Income Is Important When Investing In Real Estate
A viewer of the YouTube channel of PerFinEx (the #1 English-speaking & independent financial advisor in Germany) commented that any investor knows, that investing in real estate without passive income would be a sure way to failure. Is that so? Should you invest in German properties ONLY if you receive an immediate positive cash flow from rent – or is that not realistic at all given the current state of the German real estate market? 🤔
Let us take 10% as a rule of thumb in closing costs that you have to pay on top of the property value. Any downpayment a bank might require would mean you have to invest additional money. That is a lot of savings that you need before you can even start thinking about buying a property. And if your property is returning no passive income but a negative cash flow, it means you have to invest additional money into your real estate investment every single month.
Buying a property with negative cash flow is bad for multiple reasons:
- If a property is costing you e.g. 250€ negative cash flow per month, 2 properties will cost you 500€/month, and so on. So with every property, your free liquidity and creditworthiness are going down which is the exact opposite of what real estate investors want. They want a higher creditworthiness to leverage their investments by taking more credit from a bank.
- A real estate investing strategy with negative cash flow is depending entirely on your income. What if your income goes away for some reason? You might lose your job, you might get sick, or your company might go bankrupt. As soon as your income is gone (for just a while), investment properties with negative cash flow will eat your savings. And as soon as they are gone too, you might be forced to sell your property (maybe at a bad time when the market is going down).
We can probably all agree on this: The absolute best-case scenario would be to buy a property that returns immediate passive income with a 110% mortgage that covers not just the property, but also the additional closing costs (especially in times of high inflation). Meaning you don’t have to invest a single Euro from your own money because the property pays completely for itself. Is it realistic to find a property like this? 🤔
The Real Estate Cash Flow Reality In Germany
Buying a property in Germany that is returning passive income is what a lot of real estate investors desire and it sounds easy as well, but it is actually not. In order to generate passive income for yourself, a property needs to produce more rental income than expenses. As (net) rental income is summed up easily, let us take a closer look at the expenses you might have when investing in real estate in Germany:
- Principal: Generally speaking, a bank requires to pay 2% principal per year as part of the mortgage
- Interest: The current realistic mortgage interest rate as of writing this article is around 4% p.y. (subject to change)
- Renovations: In order to have a great rental property in the future as well, you need to maintain it and invest additional money
- Management: A property manager that is taking care of your investment property will decrease your cash flow further
- Vacancy: No matter what your return on rent is, if your rental property is empty, it doesn’t return any passive income at all
All the costs above are potentially decreasing your passive income from investing in real estate. Let us make the extremely unrealistic example that renovations, management, and vacancies do not exist at all and you only need to pay principal and interest to the bank where you got your mortgage. In that case, you would need to find a property returning 6% passive income from return on rent (2% principal + 4% interest).
Where can you find properties with a +6% return on rent?
The Postbank Wohnatlas of 2022 is showing the “multiple” that is dividing property value by net rent in order to find regions in which properties are returning a positive cash flow and passive income.
- A property worth 100.000€ returning 10.000€/year in rent has a return on rent of 10% and a multiple of 10.
- A property worth 100.000€ returning 5.000€/year in rent has a return on rent of 5% and a multiple of 20.
In order to find a property with a 6% return on rent (which is our absolute minimum to receive passive income) would need to return 6.000€/year in return with a multiple of 16,67.
A multiple of 16,67 leaves us with only the dark green areas that have a multiple smaller than 22,5. And most A- & B locations have a multiple of +32, meaning a return on rent of a maximum of 3%, not a minimum of 6%.
Property prices in Germany have far outpaced the growth of rent prices over the last +10 years making it very difficult to find properties returning passive income from the very start (“price-to-rent ratio“).
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Why Real Estate With Negative Cash Flow Is Fine
The reality is, that it has become almost impossible to find investment properties in Germany that return passive income right after buying them. The only affordable properties are in regions you probably don’t want to invest in because vacancies will eat you alive. A high return on rent will be a 0% return on rent if you cannot find a tenant in the backend of nowhere.
If we were in your shoes, we wouldn’t focus too much on passive income when investing in real estate. Other factors are much more important when it comes to making a great real estate investment. Here is why: Imagine you find the 1 in a million property that returns 7% passive income in terms of return on rent. Would you buy it? 🤔
Of course, you would buy the property because it returns an immediate positive cash flow. But if you increase your principal you pay the bank from 2% p.y. to 4% p.y. now, suddenly the property you thought was a great investment returns a negative cash flow (7% return on rent vs. 8% mortgage). Even though nothing changed with the property fundamentally, you don’t receive passive income anymore.
The example above shows you the pitfall of real estate and passive income, especially for many new real estate investors. You need to look at why there is no passive income. Maybe you are buying in the city center of an A-location hoping for a big increase in property valuation. Foregoing small positive cash flow while betting on. a big increase in property value is a fine trade-off, isn’t it?
To us at GermanReal.Estate it is fine to buy properties with negative cash flow if you know how to manage the risk. Especially given the after-tax cash flow will be positive much sooner than the pre-tax cash flow as a real estate investor. If you would like to invest in properties in Germany while receiving immediate passive income, check out what kind of real estate security tokens are currently available on our marketplace.
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