Active Versus Passive Real Estate Investing – Which One Is Right For You?

Active Versus Passive Real Estate Investing – Which One Is Right For You?

Active Versus Passive Real Estate Investing – Which One Is Right For You?

Did you know that you could invest in real estate without the headaches of tenants, toilets, and termites? It’s true – you can get all the benefits of investing in real estate, without any of the hassles of being a landlord. In this article, you’ll see what passive real estate investing means and find out if you should be an active or passive investor.

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, but the reality can be quite different. Even with a professional property management team on board, you as the landlord still have an active role in the investment. The 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.

This is how I got started and when I acquired my 1st rental single family in Orlando I was super excited and planned to acquire 9 more homes over time, while paying them off one at a time. After a few months, once my projections were totally off and unexpected repairs started to happen frequently, so I had to rethink my wealth building strategy. Keep in mind, it took me almost 1 year to acquire my 1st home which was out of state in Florida. Since, I am very analytical I ran all the numbers many times as well invested my own time and money by visiting the property as well 50 others before acquiring it. Will you have more luck with your acquisition? I sure hope so, I just don’t prefer this investment strategy but I know many others that absolutely love and make tons of money in it.

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) to manage the property and execute on the business plan on your behalf.

After my fiasco with my first rental, I started to look for other alternatives. I have invested a ton of time in researching and learning Commercial Real Estate as well as Passive Investing. You see I am a Busy Professional. I have a full time job in Tech as well as family with demanding wife and teenage 2 boys. 😉 . I simply don’t have enough time in the day to manage all my investment properties or manage Property Managers.

After learning this Passive Investing strategy I pulled the trigger and invested into a few syndication deals.

Shortly, there after I started receiving tax efficient passive income streams and mailbox money or sometimes ACH directly into my account which got me excited.

Once that happened and I exited out of a few deals, I got hooked and the light bulb went on.

Why bother investing into single family homes or small 2-4 Units,

Go BIG or Go home! 😉 You can start going BIG even though many Gurus preach you should start with small single family rentals.

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, 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 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.

#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 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.

#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.

Both types Passive and Active have advantages and disadvantages. In each of them you could make or lose money. In my experience being Passive Investor allowed me to quickly scale my portfolio as of today I have acquired more than 4000 Units over the last 5 years, while not losing any sleep nor sanity of managing so many units while being diversified across multiple sectors, geographies and asset classes. It would simply be impossible to acquire so many units being Active Investor in such a short period of time while obtaining the same benefits I described earlier.

More about the author: Alex Kholodenko

Alex is a Managing Partner at Wealthy Mind Investments.