Can landlords really earn passive income from their rental properties, or is it a myth?
In this blog post, I look at what passive income is, different techniques that promise passive income, and whether they deliver on the promise. I also provide tips on how to make being a landlord more passive, and explain what it means cost-wise to be a passive landlord.
Passive Income for Landlords at a glance
- What does Passive Income really mean?
- What do Property Gurus say about Passive Income?
- What Do Landlords Actually Do?
- Is Rent-to-Rent Passive Income?
- Final Thought: The Buck Stops with the Landlord
What does Passive Income really mean?
According to HMRC, passive income comes from investing in assets, and not from running a trade or a business, or being an employee. They give examples such as interest payments from bank accounts, annuities, and dividends from money invested in the stock market.
Forbes describes it as income that doesn’t need a significant commitment of time or effort to earn, and only minimal monitoring on an ongoing basis. They point out that rental income requires a large up-front investment, as well as ongoing maintenance and management of the property.
Clearly being a landlord isn’t the same as getting interest from money in a bank account, or dividends from stock market investments. However, is being a landlord really a way to earn money with minimal effort?
What do Property Gurus say about Passive Income?
A number of property “gurus” active on YouTube and Instagram say that landlords earn passive income from property.
One claims that landlords can earn “completely passive” income from buy to lets, HMOs, rent-to-rent and serviced accommodation, and running a property sourcing business.
A second says passive income can be earned by landlords, without doing any work, if they use a letting agent to manage the property. They recommend investing in a “ready to rent”, pre-tenanted turn-key property, to be run by agents.
However, a third disagrees, and says they don’t believe landlords can earn passive income. They see it as a marketing ploy to sell property training and mentorship.
Who’s right? Can rental income for landlords really be passive income, or is it a myth?
Let’s have an objective look at evidence for and against whether passive income is achievable for a landlord.
What Do Landlords Actually Do?
In a nutshell, these are the six categories of activities that landlords, or someone working for them, will do in return for rent.
Bear in mind that the more activities are outsourced, the more margin goes to third parties, and the less profit there is left over. Some will say that using “experts” will help increase the size of the pie. However it’s certainly possible for landlords to do all of these activities themselves. I do.
1. Sourcing and financing new properties
For many landlords, finding properties, doing deals, and arranging the finance is the fun part. It can be very time-consuming and takes skill to find a good project and run the numbers. Specialist mortgage brokers can help find finance, and some landlords manage to attract angel investors.
There are lots of courses that property investors can go on to hone their skills. They range from ones run by the NRLA to a myriad of courses on YouTube. There’s also a lot of paid-for courses available for newbie landlords.
Potential investors can also use specialist sourcing companies to source deals, and there’s a lot of money to be made in sourcing.
In short, most investors do their own sourcing, but it is possible to outsource some of it. However, it’s the investor who ultimately decides whether to go ahead a project.
2. Refurbishment of rental properties
Unless a landlord is buying a new build, it’s likely that the property will need refurbishing. It may be a full back-to-brick refurbishment if it’s in a bad state, or a quick clean and paint, with perhaps new carpets and new tiles.
The most landlords use third party contractors to do the work for them. However, the property investor needs to make decisions about issues that arise during the refurbishment, and the work needs managing. There are companies that will do it all, but again, this impacts margins.
Investors can also reduce costs by the investor taking on some jobs themselves, but it’s important to keep in mind the opportunity cost. (In other words, is this the most value-adding use of time?)
Whilst an investor can be totally hands off if they arrange for someone to manage the refurbish, this is fairly rare in practice. Most investors are involved to a greater or lesser extent, even if it’s just regular site visits to check on progress and make decisions. And the inevitable tip runs…
3. Letting rental properties
Finding tenants is a key activity for landlords. Many people use letting agents, either as part of a fully managed package, or as a standalone activity.
However, with the ability to list properties on the property portals by using services like OpenRent for a low cost, it’s an easy activity to do themselves. Especially as tenant demand is so high. I decided to self-let using OpenRent for the first time in 2022, and was so impressed, I’ve become an OpenRent Affiliate. To find out more about self-letting, click here for my blog post).
Self-letting will improve margins and enable the landlord to choose who’s right for the property, but of course self-letting isn’t passive.
4. Managing renters
Whatever the form of tenancy (single let or HMO), renters need managing, from dealing with queries, to tracking rent arrears and inventories.
Self-management by landlords is certainly not a way of earning an income passively, but it does increase profitability
Many choose to outsource to agents, which undoubtedly reduces the landlord’s active involvement. However, outsourcing management increases costs, and will have a negative impact on a landlord’s profit margins. As management fees are based on a percentage (usually 10-15%) of the gross rent, landlords don’t benefit from economies of scale as their portfolio grows.
There are four management models available for larger portfolios (agents, self-managing, hybrid, own team). The hybrid model involves using virtual property assistants to carry out the administration. This isn’t some form of property Alexa, but a real person with experience of lettings, who provides support remotely. VAs can add enormous value and make a landlord’s life a lot easier. However, they still need to be supervised.
>> Related Post: How to Manage a Growing Buy to Let Portfolio
>> Related Post: How to Self-Manage your Buy to Let
5. Repairs, maintenance, safety of properties
Repairs and maintenance are inevitable for rental properties. Boilers break, roofs leak, and pipes burst. Even in new properties. Also, landlords must ensure that regular safety checks, like the annual gas safety certificate, testing smoke and carbon monoxide alarms, and five-yearly EICRs, are carried out.
Of course, trades people will usually carry out the tests and most repairs. However, someone, whether or not it’s the landlord, needs to make decisions about what is needed, and arrange for it to be done.
Managing agents rarely inspect properties outside of the annual inspection, and are unlikely to supervise building work or repairs. They usually only have authority to go ahead with small repairs up to an agreed amount , eg £100-£250.
Unfortunately, a lot of managing agents are at best mediocre. Speak to any landlord, and they’ll have a tale of woe about how they were let down by a letting agent. I certainly have plenty.
There are some good ones around, particularly those who are run by landlords (take a look at my blog post on how to get the best from managing agents for more tips). Nevertheless, even the best agent will need to involve the landlord if a serious problem occurs.
Let’s take as an example a renter sending the above photo of mould in a bedroom. (This is a real example from one of my properties). The agent would probably arrange a report from a contractor on the cause of the mould. However, it’s not wise to leave big decisions to a letting agent and their chosen contractor. They’re unlikely to have the same understanding of the property’s history, previous refurbishments, and known issues. There’s also usually more than one way to solve a problem.
Savvy, experienced landlords will want to get to the bottom of where the mould is coming from. Quiz the contractor, and maybe get a second opinion. It’s not always obvious.
Something as serious as black mould needs to be taken seriously by the landlord. The landlord may also need to make the insurance claim, another thing an agent can’t do. Even a virtual assistant can only help with the administrative side. They’re not the decision maker.
The cause of this mould was a broken tile and a hole in the gulley on the roof. I liaised with the insurance company, and arranged for a roofing company to repair the roof. I cleaned off the mould, put in a dehumidifier and arranged for the room to be redecorated when it was dry.
Ultimately, this is not something that I could or should have delegated to an agent. It needed active management from my part.
6. Oversight of the management
The key flaw in the argument that landlords earn passive income is the matter of oversight.
If landlords delegate takes to an agent or a virtual assistant, that’s not the end of the story. They will have questions and will want to check in with you. Agents and VAs need managing. Otherwise how do you know they’re doing what they agreed to do? After a renter moves in, check to see if they’ve received the prescribed deposit information. Unfortunately it doesn’t go without saying that the agents will do everything they should. I speak from experience about this particular point.
Managing your agents or VAs is part of being a landlord, if you don’t self-manage. And that’s not passive.
Is Rent-to-Rent Passive Income?
Property influencers often recommend rent-to-rent as a way for landlords to earn “totally passive” income.
What is rent-to-rent?
With rent-to-rent, a landlord rents a property under a commercial lease agreement to an intermediate landlord, the ‘rent-to-renter’, who sub-lets the property to an end tenant.
With an authorised rent-to-rent agreement, the top landlord usually passes responsibility for managing the property to the intermediate landlord. This will include certain repairs and maintenance, but some major issues will normally fall back to the top landlord. Who bears responsibility for what is a matter of negotiation for the rent-to-rent agreement.
In a rent-to-rent, the rent remains payable, regardless of occupancy. This means the intermediate landlord takes on the risk of voids and rent arrears.
For rent-to-rent to work, the rent-to-renter needs to receive more from the end tenant, than they pay to the landlord. They typically do this by renting it as an HMO or serviced accommodation.
There are also unauthorised rent-to-rent arrangements, where a tenant sub-lets under an assured shorthold tenancy, without the landlord’s permission. This is something all landlords need to be careful to avoid.
A recent example of where this ended in court is the Rakusen case. It was about whether rent repayment orders (RROs) can only be made against a tenant’s immediate landlord (the rent-to-renter) or whether the renter can claim against the superior landlord. The Supreme Court decided in March 2023 that the the rent-to-renter, and not the superior landlord, is responsible for paying RROs.
Pros and cons of rent-to-rent
Rent-to-rent can work well for landlords. However, it can work out badly if the rent-to-renter doesn’t look after the property or comply with their landlord obligations. It can be even worse if it’s an unauthorised rent-to-rent as in the Rakusen case.
Any landlord who signs over their property to a rent-to-renter should not treat it like money in the bank. The property is a valuable asset that people are living in, and it needs looking after. Landlords should have regular meetings with the rent-to-renters to check that they’re complying with the terms of the agreement. Particularly those relating to safety and maintenance.
The landlord shouldn’t merely take the rent-to-renter’s word for it. Instead, they should ask to inspect the property, licences and safety certificates at least once a year. Property is a long term investment that needs overseeing, even if the landlord appoints a rent to renter.
Final Thought: The Buck Stops with the Landlord
Landlords provide places for people to live in, and that comes with a lot of responsibilities. It’s not something landlords should take on lightly.
All landlords need to educate themselves about their legal responsibilities, even if they use agents. They need to know what the people they delegate to are supposed to be doing, so they can check it’s being done properly. A good way of doing this is by becoming an NRLA Accredited Landlord.
If a landlord delegates any legal responsibilities to an agent, the landlord is still liable. Here are some examples of when the landlord is responsible for mistakes by agents:
- The letting agent doesn’t register the renter’s deposit. The landlord may have to pay compensation to the renter and won’t be able to serve a section 21 notice. The fact it was the letting agent’s mistake is neither here nor there. The landlord should check the agent has registered the deposit and given the prescribed information to the renter.
- The letting agent doesn’t advise the landlord to get a selective licence or HMO licence where one’s needed. It’s the landlord who’ll be committing a criminal offence and have to pay a fine and/or a rent protection order.
- The property falls into serious disrepair because the agent has not acted on repairs reported by the tenants. It’s the landlord who risks a £30,000 fine and prosecution.
Even rent-to-rent should not be entirely passive for a landlord, as they need to monitor compliance with the agreement.
Whilst it’s certainly possible for a landlord to take a more passive role by outsourcing, they still carry the can. However, if they want to ensure their property is being looked after, they’ll need to be involved to some extent. If a serious problem arises, and they’ll need to assess the situation and make decisions.
Outsourcing also comes at a cost, which reduces the amount of profit a landlord makes. Margins are already tight for landlords, especially with the increase in interest rates. If the landlord outsources everything, the net returns may be so low that it would be better to put the money in the bank.
Being a landlord comes with lots of legal responsibility. It’s irresponsible and misleading to call it ‘passive income’, as that plays down the fact being a landlord involves risk and responsibility for the safety of their renters. Importantly, they need to have the knowledge to be able to supervise their agents.
Finally, talk of landlords earning passive income is a worse than a myth. It’s dangerous as it gives the impression it’s like earning interest on money in the bank, when it comes with a lot of risk, responsibility and work.