In this article, you’ll read about passive real estate investing, and hopefully, it will help you think through whether you should be an active or passive investor.
What It Means To Be An Active Investor
When someone says, “I invest in real estate”, many people think of having rental property and being a landlord. It seems as simple as: buy a single family home, find a renter, and collect monthly rental income. At first glance, it seems pretty straight forward, but in reality, it can be very stressful and overwhelming.
Investors believe hiring a professional property management team will solve all their problems. However, as the landlord, you still have a very active role in the investment. The property manager may take care of the day-to-day tasks, but you are still responsible for strategic decisions of the investment. This can include the decision to evict tenants, filing insurance claims when surprises happen, and sometimes putting in additional funds to cover maintenance and repair costs.
What It Means To Be A Passive Investor
Contrary to the example above, passive investing is a “set it and forget it” type of real estate investment. You invest your money, and someone else does all the heavy lifting.
The great part about passive investing is that it’s passive – you don’t get any calls from the property manager, you don’t have to screen any tenants, and you don’t have to file any insurance paperwork.
However, being a passive investor also means that you relinquish some of your control in the investment and trust someone else (i.e., our management team) to manage the property and execute the business plan on your behalf.
Should You Be an Active or Passive Real Estate Investor?
Here are 10 factors to help you decide which path is right for you.
#1 – Tenants, Termites, Toilets, and Calls at 3 AM
If you’ve dreamt of becoming a landlord, having tenants, and making improvements, consider an active investor role. However, if the title to this bullet point makes you nauseous, you should go the passive route.
#2 – Time
Active real estate investments require significant time during the initial acquisition as well as throughout the project lifecycle. Passive investments generally require your time during the research phase. Once you commit your dollars, you can relax and trust the manager.
#3 – Involvement
How hands-on do you want to be? Do you want to manage the property yourself, field tenant requests, and schedule maintenance and repair appointments? Or would you be much more comfortable with someone else handling all of that?
#4 – Profits
With certain active investments, you could be the only owner of the property, so you would get to benefit solely from the profits. With passive investing, specifically with REITs, the profits are distributed among many investors.
This doesn’t necessarily mean that one type of investment will net you higher returns; you’ll need to compare one deal to another. Remember that with any investment, potential for more reward typically means potential for more risk.
#5 – Expenses
Active real estate investors should plan to handle insurance claims, emergencies, and repairs, which may require additional capital outlay. Passive investors only make an initial capital investment.
#6 – Risk and Liability
With active investing, you are personally held liable if things go poorly, which means you could lose the property and other assets if not structured correctly.
With passive investing, your liability is limited to the capital you invest. Typically, the asset is held in an LLC or LP. The sponsors are held liable if anything goes wrong, not the passive investors.
#7 – Paperwork
Active investments are typically paperwork-heavy, from the initial purchase of the property to tracking purchase and rental agreements, bookkeeping, and legal documents throughout the project.
On the other hand, when investing in a passive fund, you typically sign a single PPM (private placement memorandum) to invest in the property. There is no need to fill out lender paperwork, file for insurance, or bookkeeping.
#8 – Team
As an active real estate investor, you will need to build your team, including brokers, property managers, and contractors.
As a passive investor, you rely on the shared expertise of the existing REIT management team. We’ve dedicated several years of time and energy, established strong networks in the commercial real estate market, and have a team in place to manage our existing and upcoming properties.
#9 – Diversification
With active investing, you need to be an expert in the market and the asset class you’re investing in. If you’re investing outside your local area, you need to research the market, find a “boots on the ground” team, and possibly visit the area.
With passive investing, it’s easy to diversify across different markets since you don’t have to start from scratch with each market. You are investing with teams that have already taken the time to research those markets and build strong local teams.
#10 – Taxes
As an active investor, you’ll be responsible for the bookkeeping, meaning that you will need to keep track of the income and expenses. You’ll also need to work with your CPA to make sure that you are correctly depreciating your asset’s value, filing taxes correctly, etc. .
As a passive real estate investor, you don’t need to do any bookkeeping. Depending on the type of fund you’re invested in, you either receive a Schedule K-1 or a 1099 DIV every spring for your taxes, which shows the income and losses for that property—no need to track income and expenses throughout the year.
Passive Investing or Active Investing?
Landlords are the face of the rental property investments, and if you are ready to put in the work and get involved in all aspects of being a landlord, active investing might be the better investment path for you.
However, suppose you have the money to invest but are not interested in spending time answering the phone, driving to multiple properties, and dealing with tenant complaints. You may want to consider being a passive investor.
When determining the right path for you, be sure to factor in your personal situation, goals, and interests.