Active versus passive real estate investing, which is the best for you? Did you know that you can invest in real estate without the headaches of tenants, toilets, and termites? It’s true; I am living proof – you can get all the benefits of investing in real estate, without any of the hassles of being a landlord. And if that isn’t magical, I don’t know what is!
In this article, you’ll see what passive real estate investing means and find out ways to determine if you should be an active or passive investor, or even a combo of both.
What It Means To Be An Active Investor
When most people think of real estate investing, they think of rental property investing – buy a single family home, find a renter, and collect monthly rent income. Sounds easy enough, right. Quite possibly, but the reality can also be quite different.
Even with a professional property management team on board, you, as the landlord, still have an active role in the investment.
Property managers may take care of the day-to-day issues, but you will still need to be involved in strategic decisions, including whether to evict tenants who aren’t paying, filing insurance claims when unexpected surprises happen, and sometimes having to put in additional funds to cover maintenance and repair costs.
What It Means To Be A Passive Investor
On the flip side, you have passive investing, which are the “set it and forget it” type of real estate investments. You invest your money, and someone else does all the heavy lifting.
The great part about passive investing is that it’s totally 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., the sponsor team or operator) to manage the property and execute the business plan for the asset 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 when you’re deciding between active versus passive real estate investing.
#1 – Tenants, Termites, and Toilets
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 likely go 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.
If you are currently working full-time or have a business you are running, active investments may not be the best fit for you.
#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, or possibly have a partner or two, so you would get to keep any net profits. With passive investing, the profits are distributed among many investors.
However, this doesn’t necessarily mean 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. Passive investors only make an initial capital investment. That is all that is required of them for a given project.
#6 – Risk and Liability
With active investing, if things go south, you may be personally held liable – depending on how the asset was purchased, which means you may lose not just the property but also your other assets. Again, this depends on how the purchase and/or your entity is set up.
With passive investing, your liability is limited to the capital you invest – that’s it. 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, taxes 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. The operators provide you tax forms annually and you hand those off to your trusty accountant. Easy peasy.
#8 – Team
As an active real estate investor, you will need to build your own team, including brokers, property managers, and contractors. This can take a lot of trial and error, not to mention time, on your part.
As a passive investor, you rely on the shared expertise of the existing deal sponsor team. The sponsors are experts and typically already have a team set up to manage the property in the market the asset is in.
#9 – Diversification
With active investing, you yourself 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.
You can also diversify the asset class you are investing in. It’s up to you and diversification through passive investments can be a much quicker process than actively investing in various markets and asset classes.
#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.
Conclusion
If you’re ready to roll up your sleeves and get involved in the various aspects of being a landlord, active investing just might be the perfect adventure for you.
However, if your time is limited but you have capital to invest, you might want to consider being a passive investor.
If you’re hoping for a middle ground option, turnkey rentals and buy-and-holds may provide some control without the huge time investment.
When determining which is the right path for you, be sure to factor in your unique situation, goals, and interests.
As always, we are here to help! Contact Ohana Investment Partners today!
** Please leave a comment below and let us know whether you think active or passive investing is the best fit for you and why.