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Realities behind creating 'passive' income

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Rental income
Rental income | jpgfactory/Getty Images

Rental income

Investing in rental properties is an effective and time-honored way of earning passive income. Nonetheless, it often requires more work than people expect. If you don't spend the time learning how to make it a profitable venture, you could lose your investment and then some, says John Graves, author of "The 7% Solution: You Can Afford a Comfortable Retirement."

To earn passive income from rental property, Graves says you must determine 3 things: the return on investment you want to have, the property's costs and expenses, and the financial risks of owning the property.

For example, if your goal is to earn $10,000 a year in rental income and the property requires a $2,000 monthly mortgage plus an additional $300 a month in taxes and other expenses, you'd have to charge around $3,150 in rent monthly to reach your goal.

Now, the question becomes one of risk: Is there a market for your property? Might you get a deadbeat tenant? Will your tenant damage the property? All of these could result in a sizable dent in your passive income.

"You have to know your area and tenants really well," says Graves. "If not, you could get crushed, and it would take years to recover."

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