Real estate investing can be truly passive, but it might not be in the way you think. Being a “hands-off” passive investor can be one of the most powerful ways to make your money work for you. But before we dive into the benefits, let’s clarify what this type of investing is and explain how it is different from active investing.
Many investors starting out on their real estate journey envision buying and renting out a piece of residential property, such as a single-family home, condominium, townhouse, or perhaps a small multi-family complex like a duplex or triplex. Many investors mistake this business model as being “passive” because it’s easy to imagine the strategy playing out perfectly. After all, you simply buy a piece of property, rent it out, and then collect the checks every month from your tenants.
But unfortunately, this is not a passive real estate strategy. Those of us who have used this model, we know at a bare minimum, that we must select a property to purchase, and then work with a property management company to make ongoing decisions about the property e.g. whether to fix or replace an appliance when problems arise, or how to address unforeseen issues when they pop up. Should you re-carpet or paint the property? When is a good time to do that? Which company or contractor should be used? If you choose not to outsource these operational tasks to a property management company, you will have to manage the day-to-day responsibilities on your own. In either case, this is an active investing approach because of the ongoing time commitment and asset management required.
Try scaling this investing model to 20 properties and you quickly learn how active this investing model can be. Even if a rental property only required 5% of your time, you can see how 20 properties x 5% of your time = 100% a full-time job. There’s nothing wrong with using an active approach to investing, just be aware that it can be time-consuming and difficult to scale.
Passive investing is the strategy of acquiring income streams on autopilot. For example, as a passive investor, you make an upfront capital investment in a private placement offering (AKA real estate syndication) REIT, or stock and then receive an equity ownership stake in that investment, from which you are paid passive income or portfolio income. The biggest difference between active and passive investing is that you are not directly or indirectly managing the investment as a passive investor. It is 100% hands off property investment, in terms of your time commitment, after making the initial investment.
You can passively invest in real estate in several ways. I mentioned REITs (Real Estate Investment Trusts) which are essentially companies that pool investors’ capital together to purchase large real estate deals. I also mentioned private placement offerings or “experience real estate syndications” where you can make direct investments in individual real estate. Private placement offerings are not publicly traded on the stock market and are usually structured as a Limited Liability Company (LLC) or Limited Partnership (LP). This is a structure in which you “pool” your capital together with other investors in an equity or debt-based investment, so you can enjoy the benefits of being a real estate investor rather than a landlord.
In an equity real estate private placement, there are typically tax-deferred cash returns that allow you to keep more of your earnings throughout the hold period of the investment.
This is one reason real estate (in general) can be a more powerful passive investment compared to other asset classes. Interest payments or stock dividends can be taxed at the highest income brackets. The pass-through potential benefit of real estate ownership allows a share of the depreciation and expenses to offset the distributed income you receive from the partnership.
When you are a passive real estate investor, you do not deal directly with the hassles of day-to-day management. Clogged toilet? You’re not going to get a call at 3 am. Broken garbage disposal? It’s not your responsibility to call a handyman or make an emergency trip to your property.
Working with banks to obtain financing on your own properties can be difficult. Since the Great Recession of 2008-2009, banks started to require more documentation for you to get loans, and the loan underwriting process can be very time-consuming in itself. Not to mention banks will typically stop lending to you after you hold several mortgages due to debt-to-income ratio requirements.
When you are a passive real estate investor, your investment is handled by a professional real estate investment company the hands-off investor that already has relationships with banks and lending agencies. They navigate the bank financing so you don’t have to and the loans are based on the property itself and the loan guarantors (not you).
Quite possibly my favorite aspect of passive investing is the ability to leverage other people’s expertise and track record. In real estate, you have the option to go it alone (e.g. buying your own investment property) or you can leverage an experienced team to find and manage the deals for you.
The fact is, there are people who devote their lives to learning the ins and outs of specific markets, building broker relationships, finding off-market deals, and becoming masters in a specific niche. As a passive investor, you have the opportunity to benefit from this deep education, without sacrificing your own time and energy. If you can’t beat them, join them.
Passive investing in real estate can be as “active” as you choose to make it. Typically, you do your due diligence on the investment firm, market, and the deal, sign legal paperwork online and then transfer funds. As soon as your investment is processed, you become an equity owner in the real estate venture and can then start to realize the potential passive income and/or equity growth from the deal. In other words, you have the potential to make money while you sleep.
Of course, real estate investing carries risks, just as investing in any asset class carries risk. When you invest in any asset, you carry the risk of the loss of your principal. In the case of both a stock or a REIT investment, this can result when the value of the investment goes down, either due to internal issues with the underlying asset, the company whose shares you’ve purchased, the real estate managing the portfolio itself, or a downturn in the market. In either case, the value of your asset can decrease.
This is why it is so important that before you make any type of investment, whether in real estate or other asset classes, and whether active or passive, you must first do your own research and due diligence. No investment, person, or company can guarantee you a return or protection of all your principal. But your own due diligence can help you find safer and possibly more lucrative avenues to place your capital.
Having a passive investing mindset can be truly life-changing. However, real estate is only one asset class you can choose from. If you are interested in passive investment opportunities other than real estate, you can research other asset classes such as dividend stocks, tax liens, private notes, bonds, annuities, life insurance investing, ATM machines, venture capital, and many more. Creating passive streams of income is faster and simpler than it has ever been. One thing I have learned from speaking with thousands of passive investors, is nearly all of them wish they had started sooner. Don’t let that be a regret for you, keep up the education. Thank you for reading.
To Your Success
Travis Watts
Disclaimer: The views and opinions expressed in this blog post are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.