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The second way to add a passive stream of income is through rental real estate.

There are many ways of making money in real estate:

buying land and developing it
buying a property, rehabbing it and selling it
buying a property, living in it and selling it after a period for a higher price

All of these basically come down to making money through capital gains, i.e., buying an asset and selling it at a higher price.

In my opinion, if your goal is financial freedom, earning a steady income stream from rental property is the most preferable method of using real estate.

In this guest article "Why Invest in Apartment Buildings?", David Lindahl shows us how we can achieve financial freedom with rental properties.

You buy a property, rent it out and your wonderful tenants help you pay down your mortgage. This can be a great business when done correctly!

Look for Cash-flow Positive Properties

If you decide to use this tool in your financial freedom arsenal, you will be looking for cash-flow positive properties. This is a key concept to understand.

What does cash-flow positive mean? What does cash-flow mean, for that matter? To understand what cash-flow means, you have to understand how the cash flows in the rental real estate business.

On the income side, you have rents coming in. The property might also have other side incomes. You might have a coin-op laundry on the premises. You might be offering on-site storage to your tenants as an additional service. You might be earning money for letting others park on your property. All these incomes add up to your total gross income.

On the other side, rental real estate has all kinds of expenses associated with it. They can be divided into 2 main categories:

Operating expenses, and
Debt service

Operating Expenses

These are just that - expenses incurred in operating the property. Here are the major components of Operating Expenses:

Insurance
Property taxes
Repair and maintenance
Utilities
Trash removal
Snow removal (as appropriate)

Think of it this way. Even if you were to buy a property by paying 100% cash (that is without taking out a mortgage against the property), there will still be expenses you will incur in the running of your rental real estate business. These are your Operating Expenses. You don't really have a choice about how & when you will pay these!

Debt Service

This term refers to your mortgage payments. Debt service is where you have a lot of leeway in coming up with creative arrangements with the seller and your financiers.

You could arrange make a down payment of anywhere from 5% (currently [as of July 2009] for an owner-occupied rental property) to 25% (currently for a property where the owner does not live in the property).
Depending on the property and the rents it generates, you could decide to borrow money for 10, 15, 20 or 30 years.
Depending on the mortgage rate structure, you could get a fixed-rate mortgage or an adjustable-rate mortgage (ARM) - or a combination of the two.
You may be able to get the seller to lend you money for down-payment.

Cash-flow refers to the money you get in hand after these 2 categories of expenses are deducted, that is:

Cash-flow = Total gross income - Operating Expenses - Debt Service

In other words, cash-flow is your net profit. Naturally you want it to be positive - hence the search for positive cash-flow properties.

Other Considerations

There are a couple other ways a property-owner benefits from a tax angle. Firstly, the interest paid on the mortgage is tax-deductible. Also, tax laws provide a phantom deduction called depreciation. This page explains basic rental estate terminology you will need to understand if you choose to buy a rental property.

I have compiled many rental real estate tips which will accelerate your journey towards financial freedom.

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