Why most passive income streams aren’t really passive
With the Australian property market continuing to soar, interest rates continuing to remain low and steady (for now) and the stock market continually fluctuating, investment has become a hot topic. Chances are, if you have even a passing interest in investment options, you’ve seen the term ‘passive income’ thrown around quite a bit.
But what exactly is passive income? And are all the passive income options really that passive?
What exactly is passive income?
Passive income is making money in ways other than your usual job, profession or business. For most people, it’s an investment you’re not really engaged in managing. You buy the asset and then all you have to do is wait for the profits to start rolling in.
The Investopedia website tells us:
‘Passive income is earnings derived from a rental property, limited partnership, or other enterprises in which a person is not actively involved. As with active income, passive income is usually taxable, but it is often treated differently by the IRS.’
(While this definition is geared towards the American market, the Australian Taxation Office (ATO) also has different rules for different types of income.)
The most common types of investments often touted as great passive income streams are investment properties and share portfolios. While both of these are really great investment options, are they truly passive income streams?
Is your passive income stream really so passive?
There’s no denying these days, there’s endless ways to create potential passive income streams. With varying degrees of success, people are making a business from things like writing online courses or renting out their spare room on Airbnb.
Not to mention, the most common passive income streams, renting out an investment property or creating an investment portfolio. And while these all seem passive, meaning you don’t have to invest a lot of time to make some decent money, can any really be considered passive income?
Let’s take a closer look at the top two – investment property and investment portfolio – and see if they truly qualify as passive income.
The promise of passive income for years to come. In fact, many people buy investment property to fund their retirement. Buy the property, put in some great tenants, hire a property manager and that’s it.
But that’s not entirely accurate. Just a few things you, as a property owner, need to consider:
- Property manager – you need to make sure they’re managing your property well and keeping on top of things. They also have limited decision making capacities so you can’t leave your property exclusively in their hands
- Tenant selection – you’ll need to decide who lives in your property and you could be having to select new tenants as often as every year.
- Insurance – something you’re going to need and update regularly to make sure you’re covered
- Maintenance and repair costs – pretty self-explanatory. You may not need to authorise repairs but you will need to pay for them.
Another investment option sold as a ‘set and forget’ investment.
And again, not entirely accurate. You need to decide how you want to invest your money, how much, for how long and in what investment classes. Even when investing for the long term, you need to actively manage your investments in line with market changes or your own circumstances.
What qualifies as passive income?
Of course, many would argue the investments mentioned above do qualify as passive income streams. But if you want true passive income, true set and forget investment options, there’s really only a few ways to achieve this. The one we’re going to talk about today is investing in a pooled mortgage fund:
Pooled mortgage fund as passive income
A pooled mortgage fund is pretty much what it sounds like and is a true passive income stream.
A fund manager pools a group of investors’ funds and then loans the money out to borrowers in the form of a registered mortgage. The fund manager is responsible for everything including sourcing the borrowers, conducting due diligence and managing the loan to make sure the money and interest is paid back on time. The investor then earns their passive income via the interest that is paid on the loans.
Once you’ve committed to your investment, you really don’t have to do anything other than check your bank account for those monthly or quarterly interest payments, known as distributions. With most pooled mortgage funds currently paying between 5 and 10 percent per annum, it’s no wonder it rivals the more traditional property investments or share portfolios as a quality passive income option.
Other benefits of investing in a pooled mortgage fund
There’s no denying that investing in the Australian property market, especially with rising prices and low interest rates, is smart. But what if you want all the benefits of investing but you either don’t have the capital for a new property or don’t actually want to buy a new property. Pooled mortgage funds could be the answer.
You get to invest a certain amount of money for a certain amount of time. You collect interest along the way and once the investment has been repaid, your initial capital investment is returned.
And because you can invest with as little as $10,000, investing in a pooled mortgage fund is accessible to many more people.
The pooled funds you use to invest aren’t used for just one mortgage. Rather, the money is invested across a range of mortgages. This not only diversifies your portfolio but it also reduces the risk by spreading it out across multiple mortgages. So, even if one borrower defaults on their loan, you still have the remaining loans paying a return.
Safe as houses
The loans that make up a pooled mortgage fund are secured by property. And to make the investment even more secure, a loan-to-value ratio (LVR) is set at a maximum of 75 percent. What this means is that a loan is never more than 75 percent of what the property is actually worth.
For example, only $700,000 will be loaned against a property valued at $1M. In relation to the investment, this means that if a borrower defaulted on their loan the mortgage manager would take possession and sell the security property.
The value of the property would have to fall by more than 25 percent before it may become difficult to recuperate the loan amount.
Pooled mortgage fund – a truly passive investment option
As you can see, pooled mortgage funds can create genuine passive income streams with an initial outlay of as little as $10,000.
If you’re interested in learning more about investing in APG’s pooled mortgage fund, please contact [email protected]