The Math Behind Replacing Your W2 Income With Passive Income

[Justin Moy]

There are lots of ways you get returns as a real estate investor, but to replace your active income you’re generally going to focus on your cash on cash return - or the amount of money you receive every year from cash distributions.

In this example we’ll use $100,000 as your annual income that you’re looking to replace.

Cash on cash return is measured as a percentage of return from cash distributions per year based on the amount you invested.

So let's say you invested $50,000 into a deal that has a 5% cash on cash return, that means you’d receive 5% of 50,000 that year, or $2,500. If you’d like to break that up per month you can divide that figure by 12 to get ust over $200 in monthly passive income.

Here’s how that math breaks out = $50,000 / .05 = $2,500

So, how much invested do you need to have to get $100,000 in passive income per year?

We’ll find that out by dividing 100,000 by the cash on cash return percentage of a given deal.

5% is a bit lower than we’d expect to see at least with a stabilized multifamily asset, I’d say 7% is more average.

If you’re investing in deals that give an average of 7% cash on cash return you’d take 100,000 and divide it by .07 which will give you the amount you need invested to achieve $100,000 in passive cash flow:

100,000 / .07 = $1,430,000

So if you’re investing in deals that give you a 7% cash on cash return you’d need to have $1.43M invested in those deals and you’d receive $100,000 in passive cash flow per year.

Now, that amount seems high, but there are ways to get there faster than saving up a seven figure amount.

1: Start small

Most investors start investing in smaller amounts in many deals to get their money working with them to achieve their overall investing goals. To just save up from your W2 job is a tough path, but to have your W2 job + your investments fueling your cash flow accounts, you’ll get there much faster.

2: Change your strategy early on

With most deals, there is a tradeoff of cash flow and appreciation. Early on in an investors career, it’s not uncommon for them to pursue higher equity multiple investments rather than stabilized cash flowing assets.

Value add deals that involve buying a distressed asset, fixing it up, and selling it for greater profits in shorter amounts of time is a great strategy for building up a war chest quickly, rather than investing in stabilized cash flowing deals. These types of assets will have much lower cash flow but returns in or close to the 20% range are realistic.

3: Look at higher cash flowing assets

In this example I used 7% as a benchmark for stabilized multifamily, but there are other assets that have higher cash returns that you can look into.

NNN leases, ATM funds, or short term rental funds can be great examples of assets with higher cash returns. The tradeoff could be less appreciation than residential assets.

Right now we’re working with a short term rental fund that is seeing 9% in cash flow, meaning to get to $100,000 in passive cash flow there you’d only need to invest $1.1M instead of $1.43M.

Here’s a breakdown of how a greater cash return can greatly lower the time needed to achieve $100,000 in passive cash flow:

7% - 100.000 / .07 = $1.43M

8% - 100.000 / .08 = $1.25M

9% - 100.000 / .09 = $1.11M

10% - 100.000 / .10 = $1M

11% - 100.000 / .11 = $900K

12% - 100.000 / .12 = $833K

The first step to getting $100,000 in passive cash flow is to determine the cash return you’re looking to get in your investments, then take $100,000 and divide it by that percentage.

Whatever number you get, don’t worry about investing that amount from day 1, look for shorter term investments that have higher appreciation and equity multiples for you to start out with so you can get on a path to multiply your money enough times until you achieve the amount you need to have the passive cash flow you’re looking for.

[Bill B.]

The good news is you probably need much less than this. 

First a $100k w-2 is only worth about $75k in cashflow after taxes. 

Using your math year 1) $100k buys $400k property and brings in $7k/yr. Depreciation on 80% is $320k means a tax write off of $11,600. You’ll actually owe negative taxes. And that’s before you start using your cashflow for business expenses like a cellphone, a computer/iPad and internet getting 25% off on them. 

After just a couple years of rent increases you're making that 8-9-then 10% COC. (Although I'd argue ROE is a better measure.) heck after 4-5 years you'll probably take all your cash out anyway.

If you want a target shoot for $150k year almost tax free in 10 years. I’m at $191k 8 years after spending 6 years and $305k cash out of pocket (all of which could be taken out with loans but I hate owing money). That’s long term passive income with a PM. Low taxes and insurance combined with low maintenance and no state income tax helps a lot. 

In regards to why I disregard COC besides as I said you could take all your cash out for infinite COC. Because of rent increases My COC is 63% while my ROE is under 7%.