Was reading Shane Parrish's Farnam Street email newsletter yesterday about Stability and wanted to expand on it for real estate investors.
Shane points out that there are two types of stability: passive and active. He goes one to talk about how passive stability requires no intervention while active stability does require intervention.
In general, real estate has active stability. If you don't pay taxes on your property—even if it is free and clear—you'll lose it. However, I think some parts of real estate investing can be broken down as passive or active.
For real estate investors, here are some examples of parts of the real estate investing process that have passive stability:
- Amortizing Mortgages – Amortizing mortgages pay off over time; at the end of the loan term the loan is paid off. As long as your tenants are paying your mortgages, this will eventually result in a free and clear property (which is even more stable). Interest only loans and balloon mortgages are not passively stable.
- Buy-and-Hold Real Estate Investing – Buy-and-hold real estate investing is more passive stable than a strategy like fix and flips and, to a lesser degree, strategies like lease-options and BRRR.
- Relying on Cash Flow in Retirement – While not completely passive, it is passive compared to the strategy of relying on appreciation and debt paydown to fund your retirement (through either selling or refinancing properties).
And, some that have active stability:
- Interest-Only Mortgages – With interest-only mortgages you are not paying off principal on the loan. At the end of the loan term, you owe the same amount as you owed at the start. You must then pay off, sell or refinance the property. This is active stability.
- Balloon Mortgages – With balloon mortgages the balance of the mortgage is due at a pre-defined date in the future. On or before that date, you must pay off, sell or refinance the property. This is also active stability
- Fix and Flips – Once you buy the property, you need to fix it up and then sell the property making this very active stability.
- BRRR – Once you buy the property, you need to fix it up and refinance the property making this very active stability.
- Lease-Option – When buying on lease-option you need to exercise your option (and in most cases get a loan for the purchase) or sell your option. These are both active stability. When selling on a lease-option you need to sell the property to a tenant-buyer (and they need to get a loan, have the property appraise, etc). This is also active stability.
- Relying on Equity in Retirement – Relying on property price increases and loan paydown through property sales or cash out refinances to fund your retirement is an exacel of active stability.
In conclusion, active stability requires you to take action to keep yourself stable as a real estate investor and, in many cases, requires more things to go in your favor to avoid trouble.