Exploring 4 Proven Strategies to Generate Income Through Real Estate

Owning your own home is often seen as a solid financial move, but it’s important to recognize that homeownership is not the same as owning income-producing properties. While your home may appreciate in value over time, it generally doesn’t generate monthly income. In contrast, income properties have the potential to provide both appreciation and a steady cash flow, making them a valuable addition to any investment portfolio.

At 1031 Exchange Place, we believe in the power of real estate investments to enhance financial stability and growth. By exploring different types of real estate investments, such as REITs, NNNs, DSTs, and TICs, you can unlock opportunities for income generation that go beyond the typical benefits of homeownership. Understanding these options is key to making informed decisions that align with your financial goals.

Homeownership vs. Investment Real Estate

According to the U.S. Department of Commerce, the U.S. homeownership rate reached approximately 68% last year, a post-Great Recession high. Despite challenges posed by the pandemic, the housing market remains robust, aided by low interest rates that allow homeowners to refinance and save on monthly payments.

However, while homeownership is a significant part of Americans’ wealth, it doesn’t provide the same benefits as investment real estate. Unlike your home, investment properties not only have the potential to appreciate in value but can also generate monthly income.

Why Invest in Income Properties?

Income generation is a key reason why many individuals diversify their investment portfolios to include various types of commercial, net-lease, self-storage, medical, and multifamily real estate assets. The additional monthly rental income from these properties can be used to support living expenses, reinvest, or save for the future.

Investments that are cash-flow positive may generate monthly income for investors. While real estate income isn’t guaranteed, and the market can be unpredictable, certain assets, such as properties leased to essential businesses, have proven to be resilient, particularly during economic downturns.

Now, let’s delve into the four primary ways to invest in real estate with income potential.

1. Real Estate Investment Trusts (REITs)

What are REITs?

Real Estate Investment Trusts (REITs) are companies that own, operate, or finance income-producing real estate across a range of property sectors. These sectors can include commercial real estate like office buildings, shopping centers, apartments, hotels, and even data centers. By purchasing shares in a REIT, investors can gain exposure to the real estate market without directly owning or managing any physical properties.

How REITs Work

REITs function similarly to mutual funds in that they pool capital from numerous investors to purchase and manage real estate assets. The income generated from these properties—typically through rent, lease payments, or the sale of properties—is then distributed to shareholders in the form of dividends. To qualify as a REIT, a company must pay out at least 90% of its taxable income to shareholders annually, which is why REITs are often viewed as a reliable source of income.

Types of REITs

• Equity REITs: These REITs primarily own and operate income-generating real estate. The majority of REITs fall into this category, with revenue generated mostly through leasing space and collecting rents on the properties they own.
• Mortgage REITs (mREITs): Instead of owning physical properties, mREITs invest in real estate debt, including mortgages and mortgage-backed securities. These REITs generate income primarily from the interest on these financial assets.
• Hybrid REITs: As the name suggests, hybrid REITs combine both equity and mortgage investments, allowing investors to benefit from both rental income and interest from real estate debt.

Advantages of Investing in REITs

• Liquidity: Unlike direct real estate investments, REITs are traded on major stock exchanges, providing investors with the ability to buy and sell shares with ease.
• Diversification: By investing in a REIT, investors can gain exposure to a diversified portfolio of properties across various sectors and geographic locations, reducing the risk associated with holding a single property.
• Professional Management: REITs are managed by professionals who handle the day-to-day operations of the properties, including maintenance, leasing, and financial management.

Key Considerations and Risks

• Market Volatility: REITs are traded on the stock market, meaning their prices can fluctuate with market conditions. This volatility can be unsettling for investors seeking stable returns.
• Tax Implications: The dividends paid out by REITs are generally taxed as ordinary income, which can be less tax-efficient than other forms of investment income. Additionally, unlike direct real estate investments, REITs do not qualify for 1031 exchanges, limiting tax deferral opportunities.
• Sector-Specific Risks: Different types of REITs can be affected by various economic factors. For instance, retail REITs may suffer during economic downturns when consumers cut back on spending, while healthcare REITs could be impacted by changes in government healthcare policies.

Example: Chad invests $100,000 in a REIT that specializes in owning shopping centers. The REIT pays out quarterly dividends based on the income generated from leasing space to retailers. While Chad appreciates the passive income, he must account for the ordinary income tax on dividends and consider the potential capital gains tax when he decides to sell his shares. Unlike direct property investments, Chad cannot defer taxes on capital gains through a 1031 exchange.

2. Direct Ownership of Triple-Net Leased Property

What is Triple-Net Leasing?

Triple-net leased properties are a type of commercial real estate investment where the tenant, rather than the property owner, is responsible for the majority of the property’s operating expenses. These expenses typically include property taxes, insurance, and maintenance costs. As a result, the property owner (landlord) enjoys a more predictable income stream with reduced financial obligations.

Types of Properties Suitable for Triple-Net Leases

Triple-net leases are commonly associated with properties leased to single tenants, such as retail stores, medical offices, industrial facilities, and corporate headquarters. These properties are often leased to high-credit tenants like national retail chains, healthcare providers, or logistics companies, offering additional security to the landlord.

Advantages of Triple-Net Leased Properties

• Steady Cash Flow: With the tenant covering most operational costs, the property owner benefits from a stable and predictable income stream, making triple-net leased properties an attractive option for income-focused investors.
• Reduced Landlord Responsibilities: Unlike traditional real estate investments, where the landlord is responsible for maintenance and repairs, triple-net leases shift these obligations to the tenant. This setup significantly reduces the time and effort required to manage the property.
• Long-Term Leases: Triple-net leases often come with long lease terms, sometimes extending for 10 to 25 years. These extended leases provide a long-term investment horizon with the potential for rental income increases tied to inflation or market conditions.

Key Considerations and Risks

• Concentration Risk: Direct ownership of a triple-net leased property can expose an investor to significant concentration risk, particularly if the property represents a large portion of their investment portfolio. If the tenant vacates or defaults, the owner could face prolonged periods without rental income.
• Tenant Creditworthiness: The success of a triple-net lease investment is heavily dependent on the financial health of the tenant. A high-credit tenant reduces risk, but even well-established companies can face unexpected challenges, as seen during the COVID-19 pandemic.
• Management Requirements: Despite the reduced day-to-day responsibilities, triple-net properties are not entirely passive investments. Owners must still manage the lease, ensure compliance with contractual obligations, and address issues that arise, such as negotiating lease renewals or managing tenant requests for rent relief during economic downturns.

Example: Lindsey purchases a $1.5 million medical office building leased to a radiology company under a triple-net lease. The radiology company is responsible for paying property taxes, insurance, and maintenance costs, leaving Lindsey with a consistent income stream. However, Lindsey must still manage aspects of the lease, such as collecting reimbursable expenses, negotiating any lease renewals, and responding to tenant needs. When Lindsey decides to sell the building, she has the option to defer capital gains taxes by reinvesting the proceeds in another investment property through a 1031 exchange. However, if the property represents a large portion of her overall net worth, Lindsey is exposed to concentration risk, making diversification a critical consideration.

3. Delaware Statutory Trusts (DSTs)

What is a Delaware Statutory Trust?

A Delaware Statutory Trust (DST) is a legal entity created under Delaware law that allows multiple investors to pool their resources and co-own an interest in real estate. This structure is particularly popular for holding income-producing properties, including commercial, multifamily, industrial, medical, and retail real estate. The DST structure is appealing to investors because it provides a way to own fractional shares of large, institutional-quality properties without the responsibilities of direct property management.

How DSTs Work

In a DST, the trust holds the title to the property, and investors own a beneficial interest in the trust. The property is managed by a sponsor company or asset manager, who is responsible for the day-to-day operations, including maintenance, leasing, and handling distributions to investors. This setup makes DSTs a turnkey investment solution, especially for those looking to defer taxes through a 1031 exchange.

Key Features of DSTs

• Passive Investment: Investors in a DST do not have any management responsibilities. The sponsor company handles all operational aspects of the property, making it a truly passive investment.
• Diverse Asset Types: DSTs can own various types of real estate, from multifamily apartment complexes and industrial distribution centers to medical facilities and retail centers. These properties are often high-quality assets that would be difficult for individual investors to acquire on their own.
• 1031 Exchange Eligible: One of the most attractive features of DSTs is that they qualify for 1031 exchange treatment. This means investors can defer capital gains taxes by reinvesting proceeds from a property sale into a DST.

Advantages of Investing in DSTs

• Accessibility: DSTs typically have lower minimum investment requirements, often starting at $25,000. This allows a broader range of investors to participate in high-quality real estate investments.
• Income Potential: Investors receive regular income distributions, usually on a monthly basis, which are derived from the property’s rental income. While this income is taxable, it is often partially sheltered through depreciation and other tax deductions.
• Diversification: By investing in a DST, investors can diversify their real estate holdings across different asset types and geographic locations, reducing risk compared to owning a single property.

Key Considerations and Risks

• Lack of Control: Investors in a DST have no control over the management of the property. All decisions are made by the sponsor company, which could be a disadvantage for those who prefer a more hands-on approach.
• Illiquidity: DST investments are not easily sold or liquidated, which means investors should be prepared to hold their interest for the duration of the investment, often 5 to 10 years.
• Market and Operational Risks: Like any real estate investment, DSTs are subject to market fluctuations and operational risks. If the property underperforms, income distributions may be reduced, and the value of the investment may decline.

Example: Blake invests $100,000 in a DST that owns a $10 million industrial property leased to a Fortune 500 logistics company. Each month, Blake receives a share of the rental income, which is taxable but partially sheltered through depreciation deductions. When the DST eventually sells the property, Blake can defer taxes on any capital gains by reinvesting in another DST or investment property through a 1031 exchange. This passive investment approach allows Blake to benefit from high-quality real estate without the burdens of direct property management.

4. Tenants-in-Common (TIC) Properties

What is a Tenants-in-Common (TIC) Structure?

Tenants-in-Common (TIC) is a form of property co-ownership where multiple investors hold undivided fractional interests in a single property. Each TIC investor owns a specific percentage of the property and shares in the potential income and appreciation based on their ownership stake. Unlike other real estate structures, TIC investors hold title to the property individually and have the right to sell, lease, or transfer their interest independently of the other co-owners.

How TICs Work

In a TIC arrangement, the investors collectively own the property, but each investor’s ownership interest is distinct and can be bought or sold independently. TICs are often used for larger commercial properties such as office buildings, apartment complexes, and retail centers. Investors typically receive their share of rental income proportionate to their ownership percentage and are responsible for their share of the property’s expenses.

Key Features of TICs

• Ownership Rights: Each TIC investor holds a deeded interest in the property and has a say in major decisions, such as leasing, refinancing, or selling the property. This provides more control compared to other passive investment structures like DSTs.
• Shared Income and Expenses: Income generated from the property is distributed to TIC investors based on their ownership share. Similarly, expenses such as maintenance, taxes, and insurance are also divided proportionately among the investors.
• 1031 Exchange Eligibility: Like DSTs, TIC properties qualify for 1031 exchange treatment, allowing investors to defer capital gains taxes when they sell their interest and reinvest in another property.

Advantages of Investing in TICs

• Direct Ownership: TIC investors own a fraction of the property directly, giving them a tangible stake in the real estate and the ability to influence decisions related to the property.
• Potential for Cash-Out Refinance: TIC structures may allow investors to pursue a cash-out refinance after a period of ownership, enabling them to access their equity and reinvest in other assets while still maintaining their original investment.
• Flexibility in Exit Strategy: Since each TIC investor owns an individual interest in the property, they have more flexibility in selling their stake or transferring it to another party, offering a potential exit strategy that is more flexible than other investment vehicles.

Key Considerations and Risks

• Active Involvement: While TICs offer more control, they also require more involvement from investors. Major decisions about the property are typically made by a vote of the co-owners, which can be time-consuming and require consensus.
• Risk of Disagreements: The need for agreement among multiple owners can lead to conflicts, especially when it comes to decisions about property management, lease terms, or the sale of the property. These disagreements can potentially disrupt the operation and profitability of the investment.
• Illiquidity and Management Complexity: TIC investments are generally illiquid, and selling a fractional interest can be challenging. Additionally, managing a TIC property can be complex, especially if the investors have different objectives or expectations.

Example: Christopher invests $100,000 in a TIC structure that owns a 98-unit multifamily apartment building. Each month, Christopher receives his proportionate share of the rental income, which is taxable but can be partially sheltered through deductions like depreciation. As a TIC investor, Christopher has the right to vote on major property decisions, such as whether to refinance the mortgage or sell the property. When the TIC property is eventually sold, Christopher can defer capital gains taxes by reinvesting his proceeds in another investment property through a 1031 exchange. However, he must also be prepared to navigate the complexities of co-ownership and the potential for differing opinions among the other investors.

The Bottom Line

Investing in income-generating real estate can be a powerful way to diversify your portfolio and create additional revenue streams. Unlike traditional stock and bond investments, real estate offers the potential for both income and appreciation, which can be particularly appealing to those looking for steady cash flow. By understanding the various investment vehicles available, such as REITs, triple-net leased properties, DSTs, and TICs, investors can choose the options that align best with their financial goals and risk tolerance.

Each investment approach comes with its own set of advantages and challenges. REITs provide liquidity and ease of entry but are subject to market volatility and lack the tax advantages of direct ownership. Triple-net leased properties offer a more hands-off investment experience with predictable income, but they also come with risks such as tenant concentration and management responsibilities. Meanwhile, DSTs and TICs offer opportunities for more passive or active involvement, respectively, along with the benefits of potential tax deferral through 1031 exchanges.

Ultimately, the key to successful real estate investing lies in careful selection and diversification. By spreading investments across different property types and ownership structures, investors can mitigate risks and capitalize on the strengths of each approach. At 1031 Exchange Place, we are committed to helping you navigate these opportunities, ensuring that your investment choices are well-suited to your long-term financial objectives.