Your Passive to Active Ratio is the amount of passive income you have coming in each month compared to the active income you have each month. Passive income is income that you don’t have to trade your time for – money made while you sleep. A good example of this is rental income. Active income, on the other hand, is money you go to work and trade your time for – your day job.
The idea behind the Passive to Active Ratio (P/A Ratio) is to build your passive income level to that of your active income so that you can replace your active income with passive income. This is the point where you experience tier one financial freedom. To me and many others, that’s the name of the game – the reason people choose to invest in real estate. Building your passive income is paramount!
There are great ways to earn both passive and active income in real estate. The pursuit of most real estate investors in to be active in creating their passive income (yes, it actually takes work despite what Gurus may tell you) to the point where they can glide like an eagle once their passive income is high enough. For a good breakout of how you can get started actively investing and building your portfolio check out the Active Investor Toolkit I created to help with that. I also created a great Passive Investor Toolkit, made to show passive investors how they can build their passive income without sacrificing (too much of) their time, which is the ultimate goal whichever path you choose. The Multifamily Journey Podcast is also a great place to listen to other investors who have found success chasing passive income!
So how do you determine your Passive to Active Ratio?
It’s pretty simple:
- Determine Your Passive Income
Where is your passive income coming from? In the book Wealth Can’t Wait, one of the Authors, David Osborne, talks about adding streams of income. He has built massive wealth by establishing expertise and then creating a passive income stream out of it.
For example, he spent years building a real estate brokerage where he, and mostly agents under him, sold houses.
That created a source of income.
He invested that income into rental properties.
That created a source of income.
He wrote books like the one I mentioned, among others.
That created a source of income.
He started a mastermind for other investors and entrepreneurs.
That created a source of income.
What are your streams of passive income? If you don’t have any, now is the time to start building them! Then count up all the dollars coming in from passive sources and determine your monthly passive income.
2.Determine Your Active Income
This one is straight forward. If you have a job, how much are you earning from that job? Each day you go into work, spend time doing tasks for your boss or organization, and in turn earn money for your time and/or labor. How much are you making monthly from this job?
3.Compare the Sources and Time Spent on Each
This is the most important step. Turn those two figures into a ratio. If you make $1,000/month of passive income and $3,000/month of active or earned income then your passive to active ratio is 1:3 or 1/3. Therefore, your passive income is one third of your active income or you make 33% as much passively as you do actively.
The next step is to analyze how much time it takes for each of those activities. It’s important to realize where your time is spent and how much it is earning you. Not everyone thinks this way, but by doing so it will help you realize where you need to be spending more time.
Curls for Your Financial Freedom Muscles
This is the fun part! This is where you get to put that information into action. Once you know your Passive to Active Ratio, it illuminates where you are compared to where you want to be.
Finding where you want to be may take additional introspection and will be absolutely worth it. In other words, you should decide where you want to go before buying your bus tickets.
Going with the numbers from earlier, if your monthly expenses are $3,000/month then you are going to need some more passive income before you can hit tier one financial freedom where your monthly passive income meets your monthly expenses. This means that trading your time at work to pay your bills is no longer necessary. That’s when the magic happens – if you let it.
This is where financial freedom curls come in. Where can you add more passive income? What income streams can you grow? What income streams can you add? How can you increase your P/A ratio? Where can you cut expenses to reach financial freedom earlier? These are the questions you need to start asking once you know where your P/A Ratio is because the answers are what will lead to your desired destination, whatever that may be.
I’m biased, but I think the surest fire way to grow your P/A is buy investing in cash flowing rental properties. I choose commercial multifamily because of its scalability. For you, maybe it’s single-family homes, or short-term rentals, or storage facilities. They can all work! The point is to start focusing on your P/A ratio and to start brainstorming ways to grow it. For me, I like to partner with private investors to buy large apartment complexes that cash flow like ATMs and appreciate over time through forced and natural appreciation and provide truly passive returns to the investors. If that is something that interests you, please reach out and I will be honored to help you through the process. There are also resources and educational material available for free throughout www.mulitfamilyjourney.com
Wrapping it Up
Build your passive income! It’s as simple as that. Passive income allows you to take that trip you have been idealizing for too long. It enables you to sleep in on a Sunday morning and not worry if an errand needs ran. And it opens the door to spend more time with your loved ones than your coworkers. I urge you to go calculate your P/A ratio today. It shouldn’t take you long. And if you aren’t earning passive income yet, that needs to change! Go download the toolkits and then start analyzing properties like a madman with an affinity for manipulation excel formulas!
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Blake Dailey is a multifamily real estate investor and host of the Multifamily Journey Podcast. He has reached his financial freedom number (Passive Income > Expenses) through investing in real estate and aims to help others do the same. He helps passive investors impact their lifestyle and wealth by investing in multifamily real estate and seeks to help investors achieve the ultimate asset – Time – by making their money work so they don’t have to.
Find out about investing in multifamily with Blake at www.multifamilyjourney.com/investwhere you can also learn more about Blake, read his articles, or connect with him.
