What is your initial thought when you hear the term “real estate investing”?
You probably had the same assumption we did – that being the landlord of a small rental property was the only option you had.
That’s how we started our journey. Our pursuit of financial freedom led us to invest in numerous rental properties, one after another. We quickly realized that the more properties we acquired, the more time we spent dealing with the hassles of being a landlord.
Then we had a great realization – you CAN have the rewards of real estate investing without being a landlord and without the hassles of renters, repairs, and pest management.
This article will explain what passive real estate investing is, and help you determine whether passive or active investing is a better fit for you.
What is an Active Investor?
Most people think that real estate investing is simply rental property investing. They think it’s as easy as buying a house, getting someone to rent that house, and collecting their money every month. The reality? It can be very different from this rosey picture.
Yes, you may have a property management team who takes care of daily matters, but you are still the landlord, which means you have an active part in your investment.
Ultimately, you still make the big decisions – filing insurance claims, occasionally having to fund maintenance and repairs, evicting tenants who are delinquent on their rent.
What is a Passive Investor?
When you are a passive investor, you provide the funding, and others do the busy work. This type of investing is commonly called “set it and forget it”.
That’s the beauty of passive investing – it’s 100% passive. You don’t have to find tenants, file claims, or bother with calls from the property manager.
All that being said, you do give up some of your authority as a passive investor. Someone else, usually a sponsor or sponsor team, manages your property for you. They make the decisions 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 3AM
If you’ve dreamt of becoming a landlord, having tenants, and making improvements, then consider an active investor role.
Otherwise, if the title to this bullet point makes you nauseous, you should seriously consider the passive route.
#2 – Time
Active real estate investments require more time, during the initial acquisition and throughout the project lifecycle, while passive investments only require your time up front, during the research phase.
#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 do you want to sit back while someone else does all of that?
#4 – Profits
With active investing, you would likely be the only owner of the property, so you would get to keep any net profits. With passive investing, the profits are distributed among many investors.
This doesn’t necessarily mean that one type of investment will net you higher returns than the other; you’ll need to compare one deal to another.
#5 – Expenses
Active real estate investors should plan to handle insurance claims, emergencies, and repairs, which may require additional money at times, whereas passive investors only make an initial capital investment.
#6 – Risk and Liability
With active investing, if things go south, you are personally held liable, which means you may lose not just the property but also your other assets.
With passive investing, your liability is limited to the capital you invest. Typically, the asset is held in an LLC or LP. If anything goes terribly wrong, the sponsors are held liable, not the passive investors.
#7 – Paperwork
Active investments are paperwork-heavy, from the initial purchase of the property to tracking purchase and rental agreements, bookkeeping, and legal documents throughout the project.
With passive real estate investments, on the other hand, you typically sign a single PPM (private placement memorandum) to invest in the property. No need to fill out lender paperwork, file for insurance, or do any bookkeeping.
#8 – Team
As an active real estate investor, you will need to build your own team, including brokers, property managers, and contractors.
As a passive investor, you rely on the shared expertise of the existing deal sponsor team. The sponsors are experts in the market and typically already have a team set up to manage the property.
#9 – Diversification
With active investing, you would need to be an expert in the market and asset class you’re investing in. If you’re investing outside your local area, you would 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 properly depreciating the value of the asset each year.
As a passive real estate investor, you don’t need to do any bookkeeping. You receive a Schedule K-1 every spring for your taxes, which shows the income and losses for that property. No need to track income and expenses throughout the year.
Which Real Estate Strategy Is Best – Active or Passive?
Active investing might be perfect for you if you’re excited to dive into the adventures of being a landlord, roll up your sleeves, and spend time on the weekends making repairs.
However, if you have the resources to invest, but don’t have an overabundance of time, becoming a passive investor might be a better choice. Passive investing might also be great for those who don’t want to learn how to fix things or don’t have room on their to-do list for more tasks.
Perhaps you’re looking for an option somewhere in between? Buy-and-holds or turnkey rentals might offer a medium amount of control without taking up too much of your time.
It’s important to remember that you need to choose what will best meet your goals. Time-freedom, outdoor activities with our kids, and travel were our deepest desires, so passive investing quickly rose to the top as our ideal strategy.
If you dig deep and identify what you really want for your lifestyle, your family, and as your legacy, what comes to mind? Your investment strategy should factor in these desires plus your interests and unique circumstances.