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Active vs Passive Investing in Real Estate: Which Style Fits You?
Active vs Passive Investing in real estate has become a common dinner discussion topic in our household. I talk so much about apartment value add syndication, appreciation, equity, and passive investing that my friends are fast-becoming experts themselves!
This is one of my favorite topics and I know there are many more people out there that don’t have this information, hence the motivation for me to do this blog. In case the passive investor vs. active investor waters are a bit muddy in your mind, this article is for you!
Passive vs. Active Investing
We may think we know what these terms mean, but let’s break them both down once and for all.
Let’s suppose you purchase a home and fix it up with the intention of renting it out for cash flow and building equity. You may manage the property yourself, finding tenants and fixing issues as they come up yourself, or you might hire a property management company to handle the day-to-day issues of your rental property so you can focus on other high value areas of interest, such as work and family.
This is an example of active investing.
In contrast, let’s look at an example passive investing.
Suppose you invest your money into a real estate syndication. Let’s bring some specificity to this example further, and say it is a multifamily syndication. Because you don’t officially own the property (it is owned under the syndicate’s LLC), there is no hands-on management required from you.
This is passive investing.
If you are a busy person, perhaps with a high-stress job that already takes more of your time away from your family and leisure than you like, then active investing may not be the best fit for you.
However, if you’re looking for a way to take advantage of the often killer real estate return on investment without having to fix up a property and oversee a property management company, than passive investing is right up your alley.
Of course, whether you opt for active or passive approach may not only depend on how much time you have, but your personality.
Are You an Investor Who Likes Control?
Active investing is typically best for experienced investors who prefer to have full control of their investment. - Photo by Canva
If you’re someone who likes to have a lot of control, then you may be an active investor.
Passive investors generally are limited partners in real estate syndication deals. For the passive investor, it’s all about putting capital up and keeping a distance while an experienced sponsor takes the investment funds to acquire and manage a real estate syndication.
As a passive investor, you have little control over the details of the business plan. It’s all about trusting your sponsor and letting them lead the charge. Presuming you did your homework (which is work in and of itself) you’ve researched your sponsor and will likely have complete faith in their experience and expertise.
On the other hand, active investors have direct control over the business plan. An active investor puts up the capital as well as the elbow grease in an investment property. Everything from acquiring and upgrading the property to identifying tenants, the active investor spearheads the entire effort from start to finish.
Are You an Investor with a lot of Time?
Do you have the time to shop for a new property, go through the purchase process, fix it up, screen new tenants, answers their calls, show available units, fix leaks, and complete the rest of the landlord’s to-do list? If you’ve answered “yes” to all of the above, then you are fit to be an active investor. - Photo by Canva
If you’re an investor who can invest not only money but time, then you may be an active investor.
As a passive investor, once you research and vet the sponsor, there’s little else for you to do. All of the day-to-day work is in the hands of the syndicator, leaving time on your side.
How do you Handle Risk?
If you’re an investor with a high risk tolerance, active investing may be for you!
However, for those investors who prefer less exposure to risk, then passive investing may be a better fit. As a passive investor, you simply put up the capital and have confidence that your experienced sponsor will run a successful real estate syndicate deal. In addition, these deals are more certain as far as returns go. Prior to signing the deal, you will have a good idea of the projected returns (both the monthly payouts as well as at sale). Generally, passive investors have options to join larger projects, thereby diversifying their risk to multiple markets, sponsors, and investments at scale.
Active investors can tolerate more risk. With more risk comes great responsibility, as well as the potential for greater returns. Because the active investor has a 100% stake in the deal, they recoup all of the profits. However, if the investment doesn’t pan out then the losses all fall on the investor. A value-add or a fixer-upper rental property can potentially have a big windfall. However, unforeseen expenses have the potential to wipe out recent gains and could potentially put the active real estate investor in the red.
“He who makes $25,000 annually through passive income is more enviable than he who earns $100,000 annually through a salary.” Mokokoma Mokhonoana - Photo by Canva
While passive investing via a real estate syndication is fairly passive (after you do your homework on each syndicate’s track record of course!) someone in the partnership is doing A LOT of active work. In fact, here is just a snapshot of the responsibilities of the General Partner of the syndicate, or check out Joe Fairless for the exhaustive list.
Select potential target investment markets
Evaluate potential target investment markets
Select 1 to 2 potential target markets
Find, interview, and select a property management company
Find, interview, and select a commercial real estate broker/s
Find, interview, and select a commercial mortgage broker or lender
Find a business partner
Find a real estate attorney
Find a securities attorney
Find a loan guarantor
Submit LOI and negotiate PSA
Perform due diligence on the deal
Create an investment summary
Create legal documents and send to investors
Ensure passive investor money is transferred
Set up operating bank accounts
Close on deal
Create investor guide
Send quarterly financials to investors
Send K-1 tax documents to investors
Oversee the sale of the asset
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Which are You?
Hopefully this article gave you a good idea of the strengths and weaknesses of both the active and passive investing approaches. While there are other elements at play, such as whether you are an accredited investor or not that you may need to consider, both of these investment strategies basically come down to three things: tolerance to risk, time commitment, and control.
Delphine Nguyen, Investor
Delphine Nguyen is a real estate investor and a licensed real estate broker in Illinois. She learned to be successful from a variety teachers, including her own mistakes. Real estate investing is her passion. Helping others to achieve their goals is another passion that she has. She does what she knows best, therefore, her focus is solely on multifamily and co-living investment types.
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The tax advantages of multifamily investing, including K-1 losses, are what make this kind of real estate investment so attractive.
Asset protection is simply the steps one takes to guard their wealth legally, without tax evasion.