Many of the people I speak with about real estate investing are learning about the many strategies available and a common theme is they would like to maximize their return on investment while minimizing the time and effort they spend on that investment. This naturally leads to the “Do you want to be an active or passive investor?” conversation. In order to arrive at an answer, there are several factors to consider.
What are your investment goals?
It is important to go back to this fundamental question. Being clear on your investment goals is critical in helping you to narrow your focus to opportunities that are aligned with what’s most important to you. Some of the questions to ask yourself are:
- Are you looking to supplement your income or do you aspire to replace your income through investing and leave your current job?
- Are you wanting to create cash flow in the short term, or are you more interested in building long term wealth with investments that will increase in value over 5-10 year, with your return coming on the exit?
- How much time on a weekly basis are you able to commit to managing investments?
- How much time and energy are you willing to devote to education, networking, and “deal finding”?
- How much legal and financial risk are you willing to take?
- How important is it for you to have direct control over the asset you are investing in?
Once you are clear on the answers to these questions, the decision between active or passive, or maybe a combination of both will be easier. But first, let’s look at what the distinctions are between the two, and the potential benefits and challenges of each.
What is active investing?
An active real estate investor may operate in the single or multifamily space and focus on several strategies such as long term rentals, short term rentals (ex: Airbnb), or fix and flips. Active investors find the properties, get them under contract, get them funded, and then manage the asset.
Active real estate investing requires extensive knowledge to identify strong investment opportunities, acquire assets, and actively operate them either by self managing or through a professional property manager. Active investors take on the majority of the risk and have direct control over the business decisions.
Benefits of being an active investor
- You have full control of the business decisions (with your partners if applicable)
- If you are self-funding the investments, you retain a high percentage of the equity
- If you qualify as a Real Estate Professional you could benefit from tremendous tax incentives. (this is a topic on its own)
Challenges as an active investor
- Assumption of all financial and legal risk
- Active investors take on management responsibility (even if they have a property manager)
- Requires extensive knowledge of the market and quality relationships to identify and acquire high quality assets at a good value.
What is Passive Investing?
Passive investors (limited partners) can invest through syndications, crowdfunding platforms, real estate funds, and REITS (real estate investment trusts) and share in the cashflow, equity, and tax benefits of real estate investing without taking on operational or management responsibility.
Passive real estate investing is often the ideal option for professionals who want the benefits of investing in real estate but do not want to commit the time and effort required to acquire and operate properties.
Benefits of passive investing
- No management responsibility and very limited liability risk. Once you vet the operator & asset and contribute your capital, your work is done.
- Ability to leverage the experience, connections, and knowledge of high quality operators who are experts at operating real estate investment properties.
- Diversification- As a passive investor you can invest across multiple investment properties and geographies to diversify your portfolio.
Challenges of passive investing
- Limited decision making authority. As a passive investor, you are trusting the “sponsor” to make the best possible business decisions for the asset.
- Fees- this varies a lot based on the structure of the investment. A REIT for example, will have a higher fee structure than a typical syndication.
- Reinvestment risk- When investing in a syndication, there is usually a planned hold period of 3-7 years. Significant profit can be made in this time, but once the property is sold, passive investors need to decide how they will reinvest their original capital and profit.
Which is right for you?
Only you can answer this question and I know many investors who invest both actively and passively.
What I have found is that active investors have a passion for the business. They enjoy working on these projects and are energized by investing the time and energy building the relationships, becoming experts in their market, and optimizing the management of their assets.
There are many others who love the cash flow, appreciation, and tax advantages of investing in real estate, but would rather leverage experts to handle the operations and invest their time and energy into things THEY are passionate about. Passive investing is the perfect option for this group.
Maybe it is already clear to you which is the right choice for you and maybe you still need to do some research to make that decision. Either way, I am happy to discuss more with you one on one so you can gain more clarity.