I got my first taste of real estate at 22 when I bought a condo working full time while putting myself through school. Shortly thereafter, I read a few real estate classics like “Rich Dad, Poor Dad” and “Think And Grow Rich.” I could see the potential in real estate and thought that becoming a landlord was the way to go.
So, I invested in one rental property after another – foreclosures, short sales, 1920’s remodels – but the more properties I had, the more time was required to deal with landlord-type issues. I became Erik, the real estate guy, and I was helping people by solving their real estate needs, but burning the candle at both ends and knowing full well this wasn’t sustainable.
That’s when I discovered that you can actually invest in real estate without the headaches of “the 3 T’s” – tenants, toilets, and tremors as we say here in Seattle. It’s true – you can absolutely reap all the benefits of investing in real estate, without any of the hassles of being a landlord.
In this article, you’ll discover what passive real estate investing means and find out whether you should be an active or passive investor.
What’s An Active Investor?
When most people think of real estate investing, they think of residential 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.
In managing my own properties, I’ve shoveled snow for days-on-end, sacrificed my Friday night to shop vac sewage water and unclog toilets, had run-ins with possums, rats and even a mountain beaver in crawl spaces, and more. You want some crazy landlording stories? I’ve got ‘em!
But even if you hire a professional property management team, you as the landlord still have an extremely 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.
What’s 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. You get to sit back and collect distributions and gains without a worry in the world about the day-to-day operations on the property.
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.
There is one caveat. 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.
Go back and reread this section if you want, but yes, I’m saying you get all the monetary benefits out with zero effort in. Amazing, right?
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, Toilets and Calls on Friday Night
If you’ve dreamt of becoming a landlord, having tenants, and making improvements, then consider an active investor role. Just remember to always have a pair of “Toilet shoes” in your trunk…
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 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.
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.
On the other hand, if your passions are elsewhere and your time is limited, but you see the potential in real estate, you might want to consider being a passive investor.
Turnkey rentals and buy-and-holds are some middle-ground options since they may provide some control without the huge time investment.
When determining whether active or passive investing is right for you, be sure to factor in your unique situation, financial goals, and interests.