ARE YOU AN ACTIVE OR PASSIVE REAL ESTATE INVESTOR - Take the quiz
Did you know that you could invest in real estate without having to meet with tenants? Without having to fix broken toilets at 3 am? And without having to meet with brokers and property managers? Without having to do much at all.
This can't be true? What is this passive real estate investing stuff they keep talking about? Can you really make a good return without doing much? Nah, no way. Yes, way. In fact. In this article, I'll help you gain a better understanding of what it means to be a passive real estate investor, and how to decide whether you should invest actively or passively in real estate.
Some of my experiences as an active investor.
When I first heard about passive real estate investing through real estate syndications, I'd been investing actively in real estate for a long time already. As lucrative as it can be, it can come with some pain-in-the-butt scenarios. The first mistake I made was hiring a friend as my property manager (my fault, not his). A lovely "gal" told him she would get the first month's rent and damage deposit to him first thing the next day. She was allowed to start moving, regardless. Oops... He never doubted her sincerity; she seemed like a nice girl. And from what I understand from the nosy neighbor, quite attractive (you think that might of had something my friend's trust in her?). She went on to squat in the house for 6 months, without ever paying a dime. She was a professional tenant. The judge clearly recognized her at the eviction hearing. "Oh, you again - he said." That was in Seattle, and in some states, they take mighty good care of their tenants - even if they are criminals (which it turned out she was). Yep, you might want to get a background check.
Even hiring a property manager doesn't make all your problems go away. After another property was under management, I received a call from a concerned neighbor saying they were having a Goth party of about 200 people. They were having a fire-performance. Does that sound flammable? The neighbors in that neighborhood loved me. These tenants also had a lovely habit of storing old couches and big, black garbage bags of who knows what out in the front yard—such great memories.
With a professional property manager to manage the properties, I still considered myself an active landlord. I was always involved with tenant selection, lease renewals, decisions on turnovers and maintenance, etc. It was less hands-on than self-managing, but it was by no means completely hands-off.
I have lots of stories about cockroaches, broken sewer lines, threats from tenants. It's the best!
My Experience Becoming a Passive Investor
While I enjoy getting my hands dirty being an active real estate investor, and still own some properties today, time and location can hamper how much you can grow your wealth. What is the most suitable? What makes the most sense, and allows me to scale my portfolio? That would be passive investments.
These are the kinds of real estate investments where I can write a check to invest alongside other investors. A team of professionals takes over the day-to-day operations, sending me quarterly dividends.
These are the "set it and forget it" investments of the real estate world.
Are the returns lower as a passive real estate investor? They can be, but not always. In fact, you would be surprised. I partnered a pair of duplexes that we actively ran, and I think I made $100k profit while putting in $120, after only 4.5 years. That's not too bad, but I am pacing several of my syndication investments to double my money in 5 years. Of course, the market has tightened for now, but anything over a 15% annualized return is pretty good when you consider you don't have to do much. And that is a great thing when your time is limited.
Now that I have kids, my time is much more valuable than the slightly higher returns I might get as an active landlord. I would much, much rather take my kids to the playground, rather than review tenant applications.
Deciding Whether You Should Be an Active or Passive Real Estate Investor
Perhaps you're on the fence about whether investing passively in real estate is the right move for you. Maybe you're curious about being a landlord, or you'd like to try your hand at flipping a property, or you're still in the early research phase of getting started in real estate investing.
I go into 5 high-level steps to help you focus in, here:
There are many things to think about, and deciding how best to invest your money can be a tough decision.
Here are 10 things you should consider when deciding whether to be an active or passive real estate investor.
#1 – Tenants, Termites, and Toilets
The first thing you should consider is whether the words above – tenants, termites, and toilets – excite you or terrify you. Does the thought of screening tenants, marketing your own property, and rolling up your sleeves to improve properties are things that thrill you, then perhaps you should consider taking a more active role in your investments.
If they don't, then perhaps you should take a backseat and become a more passive investor.
#2 – Time
How much time do you have to devote to your real estate investments? Active real estate investments require substantially more time, both during the initial acquisition and throughout the project's lifecycle.
On the other hand, with passive investments, you do some upfront research and vetting, but you do not need to put in any additional time once you invest.
#3 – Involvement
Designing a kitchen rehab, picking out the finishes, and patterns can be fun... once. I'm now at a point in my life when I'm happy for someone else to take the lead on those types of decisions.
As an active real estate investor, you get to choose those designs, vet tenants and make decisions on renovations and upgrades. As a passive real estate investor, you put your trust in someone else to do those things.
Think of it like an airplane ride.
The active investor is the pilot. The passive investors are passengers.
Everyone on the plane is going to the same place, but their control and involvement levels are very different.
#4 – Profits
As an active real estate investor, because you are putting in the lion's share of the time and work, you are also rewarded with the lion's share of the profits. As a passive real estate investor, you will be sharing your profits.
However, keep in mind that just because you are sharing profits does not necessarily mean that your investment return will be lower than if you were to invest actively. It all depends on the individual deal, market, loan terms, and other aspects.
As an active real estate investor, you will need to plan for ongoing, upcoming, and unforeseen expenses. You might save some money each month for capital reserves and emergencies, but if something bigger goes awry, you may need to put more money into the investment and/or deal with insurance claims.
In most cases, as a passive real estate investor, your original investment is the only capital you'll need to put in for the lifecycle of the project. Suppose unforeseen circumstances come up and cannot be covered by the capital reserves or other buffer. In that case, you may see lower returns for a while, but it is highly unusual to put in additional capital.
#6 – Risk and Liability
Things are all well and good when tenants are happy, and your property is doing well. But what about when unexpected things pop up?
With an active real estate investment, depending on how you structure it, you could be held personally liable, and your tenants could come after your other assets, so it's essential to take steps to protect yourself and your support.
With a passive real estate investment, your liability is limited. You are investing in an LLC or LP that holds the asset. Your stake in it is limited to your investment. If all hell breaks loose on the property, the worst-case scenario would be that you would lose your original investment; your other assets would not be in jeopardy.
#7 – Paperwork
As an active real estate investor, you should be prepared for a lot of paperwork, both during the acquisition of the property and through the bookkeeping, reports, and legal documents needed throughout the lifecycle of the project.
As a passive real estate investor, you sign one document upfront, receive monthly email updates, quarterly financial reports, and an annual K-1.
#8 – Team
As an active real estate investor, you typically put together your own team. You choose the broker, property manager, and contractors you want to work with.
As a passive real estate investor, you invest in a team that's already put together. The deal sponsor team will have already identified the broker and property managers they want to work with, so you leverage their shared expertise.
#9 – Diversification
This is one area where I think being a passive investor really gives you the upper hand. Because passive investing doesn't take as much of your time, nor do you need to be hands-on, you can invest your money into more assets. Further, those assets don't have to be local, as you are leveraging teams' expertise on the ground in each target market. Plus, I always say if you invest in a 100 unit apartment syndication and 1 person leaves, you are 1% vacant.
As an active investor, If your tenant leaves your rental house, you are 100% vacant. Plus, you must be an expert in whatever asset class and market you're investing in, which takes time and energy, so your ability to diversify into multiple markets and multiple asset types will be limited.
#10 – Impact
On the impact front, you should consider whether you want to have a broad or deep impact.
As a passive real estate investor, because you can invest in more and more significant projects, your money goes farther and can impact more people, families, and communities. However, your direct contact with those tenants is limited.
As an active real estate investor, you can have a deeper relationship with your tenants if you desire.
The Real Estate Investing Spectrum The excellent news is that if you're not 100% sure whether you want to invest passively or actively, there are options in the middle.
If you're ready to roll up your sleeves and manage your own fix-and-flip like an HGTV pro, you're likely on the spectrum's active end. If you're strapped for time and just want to put your money into an investment with more robust and more reliable performance than the stock market, you're likely on the passive end of the spectrum.
Should You Be an Active or Passive Investor? Take the Quiz!
If you're on the fence, check out the quiz below to find out where on the spectrum you land. You can download a PDF version of the quiz here.
Investing in real estate is a great way to build passive income, create long-term equity, and impact people and communities. Whether you invest passively or actively is up to you and your unique situation, goals, and interests.
Either way, there are opportunities aplenty out there for you, so you may want to try both ends of the spectrum.
If you're interested in learning about more passive real estate investment opportunities, consider signing up for the Fortress Federation Investor Club. We look forward to sharing future opportunities.