Passive Investor Tips is a weekly series hosted by full-time passive investor and Best Ever Show host, Travis Watts. In each bite-sized episode, Travis breaks down passive investor topics, simplifying the philosophy and mindset while providing tactical, valuable information on how to be a passive investor.
In this episode, Travis discusses both active and passive investing strategies and how to decide which is best for you. Deciding factors include the skill sets required and motivation behind each strategy, plus some scenarios where using both strategies might be the best choice.
Active Investing
Active investing means having an active involvement in the actual business itself for the real estate that you’re acquiring.
Required Skill Sets
- The ability to understand and underwrite properties, and to understand the analysis that comes with that.
- The ability to find deals off-market that give you your competitive edge.
- The ability to assemble teams and manage people.
- A conservative and realistic approach to project future and current expenses and potential returns for the deals that you’re doing.
- The ability to follow through on a business plan.
- Having the time to be able to dedicate to all of this.
Motivating Factors
You might be doing an active deal because you want to learn the foundation of real estate, or you may simply enjoy work that involves repairs and renovations. Active investors also earn higher profits on return than passive investors.
Passive Investing
As a passive investor, you do not have material participation in the business or deal itself. You are effectively investing in someone else’s deal or someone else’s business as a hands-off investor.
Required Skill Sets
- A basic understanding of property analysis and how real estate works fundamentally.
- The ability to network and find deals.
- The ability to manage your finances and personal budget.
- The ability to identify conservative underwriting when you’re vetting deals and doing your due diligence.
- The ability to relinquish control and just simply let others run the deal, make the big decisions, and do what they do best.
Motivating Factors
Passive investing might be for you if you want to free up your time. You may have another career or other professional interest that you focus on full-time, and investing passively would allow you to continue focusing on those interests. It’s a way to build up supplemental income without sacrificing more of your time.
Why Not Both?
Many investors choose some combination of active and passive investing. For example, active investors often invest passively as well in order to diversify their portfolios.
Additionally, commercial real estate beginners without much capital to invest often choose to start out as active investors. This strategy allows them to build up their “nest egg” in order to accumulate enough capital to create significant returns once they decide to invest passively.
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TRANSCRIPT
Travis Watts: Welcome back, Best Ever listeners, to another episode of Passive Investor Tips. In this episode we're talking about "Should I be an active or passive investor?" That's the question for you, and this is how to decide. Disclaimers, as always - I'm not a financial adviser; I'm not telling you or anyone what to do. This is simply for educational purposes only.
So you might think that you already know what I'm about to say in this episode, given that I'm a passive investor today... But you know, after all, I've spent almost equal time as an active investor and being a passive investor as I am today. So the journey started for me in 2009; I was flipping homes, I had vacation rentals, I was actively managing the business and the portfolio, various strategies, house-hacking, which simply means renting out a room or space in your home to other people... So I did that for about seven years, and then I made a decision to become a hands-off or passive investor, if you will, a limited partner in syndications, where I'm relying now on other people and their team, their expertise, their ability to execute a business plan, their ability to buy and underwrite and sell larger commercial real estate.
So with that in mind, let's talk about you and which strategy may be best for you. I want to dive into a couple of things, starting with skillsets required for each of these strategies. I will start with being an active investor, which simply means having an active involvement in the actual business itself, or the real estate that you're acquiring. And a couple of skills that I would say you need to have if you want to be competitive and successful as an active investor would be the ability to understand and underwrite properties, and to understand the analysis that comes with that. The ability to find deals off market, that gives you your competitive edge, the ability to assemble teams and manage people, a conservative and realistic approach to project future and current expenses and potential returns for the deals that you're doing, the ability to follow through on a business plan, and finally, you must have the time to be able to dedicate to all of this.
And the bottom line is that you should be compensated for your time, effort and energy. So if you're doing an active deal, where you're the person, then you should have a higher return or higher dollar for dollar amount compared to doing a passive deal. Otherwise, you've got to ask yourself, what are you doing? So you might be doing an active deal because you want to learn the foundation of real estate, or you're a handyman or handywoman... But just remember that if your returns aren't any better your expected returns than a passive deal, then you are giving your time away for free. So always keep an eye on that. You never want to take your eye off the ball of other things you could be doing to generate income in your life.
So to that point, being an active investor should bring you more profits in return, which is why a lot of people start with active strategies. We could talk about single family and small multifamily, and you being that person, but a more sophisticated approach or a more advanced approach to being an active investor could be being a general partner, or being a JV, a joint venture, and structuring things that way, where if you have limited capital to start with, which was my case, and why I became an active investor first, to build up a nest egg and then go passive - this is a great approach, being a GP or JV, because you could potentially raise money from other people and other investors to do the deals, even if you yourself don't have much money to start working with.
So always seek licensed counsel if you're going to be structuring these kinds of things. You're playing in the world of securities in a lot of cases, so not financial advice, but just something to think about and another approach to being an active investor if you're working with limited capital.
Break: [00:06:04.14]
Travis Watts: Alright, so let's switch gears real quick, and let's talk about being a passive investor, which just simply means not having a material participation in the business or deal itself. So you're effectively investing in someone else's deal or someone else's business as a hands-off investor. So the skill set required for this - and yes, it does require a skill set - to be competitive and to be successful would include a basic understanding of property analysis and just how real estate works fundamentally, the ability to network and find deals, and the ability to manage your finances and personal budget, the ability to identify conservative underwriting when you're vetting deals and doing your due diligence, and the ability to relinquish control, and just simply let others run the deal, make the big decisions and do what they do best.
And the bottom line here as a passive investor is that the beautiful thing is that you can free up your time. So a lot of LPs, limited partners or passive investors have other careers or professional interests that they're focused on full-time, so they just want the diversification, to be able to invest in real estate, but not have to be the landlord, so to speak... And this is just a way to build up supplemental income; to expand your income without sacrificing more of your time.
This strategy typically requires you to have a fair bit of capital to work with, but I do want to throw a disclaimer to that, because technically, you could start for as little as $10. If we take the example of investing passively for passive income in a publicly-traded REIT, a real estate investment trust - well, these days it's basically free to open up a brokerage account or an IRA, and some of these REITs on the public stock market trade for as little as $10 per share. So open up your brokerage account, fund it with $10, buy one share, and by technical definition, I suppose, you're a passive investor at this point. But I'll tell you, the reason I didn't start out by being a passive investor, even if I had had the knowledge that I have today, I still wouldn't have started out as a passive investor, because you've got to run the numbers and look at the reality of it. Let's say I had $25,000 to start with; that was the total amount of capital I had to deploy into something. So if I did a passive real estate deal with 25k, and let's say it had an 8% annualized return, and maybe a potential of a 20% upside. So if you run the math, that's $166 per month in passive income, and then years later, on the backend, assuming that we do have that equity pop, that'd be about $5,000. So when you look at that, all my capital is deployed, there's nothing else I can do for a number of years; it's just really not that life-altering or life-changing to have $166 per month, or even to have $5,000 be put into my bank, and three, four or five years later.
So now if we take the same example, the same metrics, the 8% yield, the 20% potential equity upside, but suppose I have a million dollars to go invest now - well, the numbers change drastically. Now I'm looking at $6,666 per month in passive income, and a potential of $200,000 in a backend profit upon the sale of that particular property or investment. And that's what really gets me excited. This can be life-altering for a lot of people, this can mean time freedom, this can mean early retirement, this could be switching to part time work... If nothing else, you just have another 6,000+ in the bank every month to do whatever you please with. So that's why it's a capital-intensive approach.
So as I always say, you do you. It really depends on you, your goals, your objectives, your strategy, your skill set as to whether you're an active or a passive investor, or maybe a combination of the two. A lot of people find that approach to be very valuable. So the most important part is that you just simply take action; it's that you do something. As the great Roman philosopher Seneca once said, "While we wait for life, life passes." So with that top of mind, to your success.
Thank you guys so much for tuning in to another short episode. These episodes are intended to be very short in nature, to give you as much value as I can, in as little timeframe as possible. If we haven't connected on social media, Travis Watts or @passiveinvestortips. I'd love to be a resource for you or anyone you think could find value in these episodes. Have a Best Ever week, and we'll see you in the next episode.
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