Blog Highlights:
- The Life Of An Active Investor
- The Life Of A Passive Investor
- Is Active Or Passive Real Estate Investing Best For You?
- Making Your Decision Between Active And Passive Investing
My love for real estate investing started when I bought my first single family rental property. I went on to purchase as many rental properties as I could. While the additional income was a benefit, I quickly realized what I had intended to be passive income was quite the contrary.Â
I had inadvertently become an active real estate investor, more commonly known as a landlord. When you’re a landlord, you’re responsible for maintenance, renovations, and repairs, as well as any unforeseen expenses.
Fortunately, I discovered there was a way to continue investing in real estate while also being able to live an independent lifestyle, where I could work when and how I wanted. Becoming a truly passive investor allowed me the freedom to not be beholden to any unexpected rental property issues. Â
Keep reading for a deep dive into what passive real estate investing means and whether active or passive real estate investing is right for you.
The Life Of An Active Investor
When most people think of real estate investing, they think of buying a single family rental property, finding a tenant, and then simply collecting monthly rent income. It sounds easy, but unless you’re entering this scenario with your eyes wide open, you could be in for some unpleasant surprises.Â
As a landlord you have an active role in the investment. Even if you hire a professional property management team to handle the daily operations, you’re still ultimately responsible for the rental property. You still have to make strategic decisions, including whether to evict tenants who aren’t paying, filing insurance claims when unexpected situations arise and footing the bill for any maintenance and repair costs.
The Life Of A Passive Investor
When you’re a passive investor, you’re able to invest your capital and let someone else do all the heavy lifting.Â
Passive investors have a truly passive role in the property. As a passive investor, you’ll never have to worry about unexpected calls from the property manager, screening tenants or filing insurance claim paperwork. Â
Choosing the role of a passive investor does require you to relinquish some control, however. Passive investors have to trust the sponsor team to manage the property and execute the business plan on their behalf.
Is Active Or Passive Real Estate Investing Best For You?
Here are 10 factors to help you decide if you should be an active or passive real estate investor.
#1 – Getting Your Hands Dirty
If you love the idea of managing tenants and being actively involved in the day-to-day operations such as maintenance, repairs and renovations, an active investor role might be a great fit for you.Â
If on the other hand you feel your stress level immediately rise at the thought of unexpected emergency calls, you should definitely consider going the passive route instead.
#2 – Time Commitment
Active real estate investments require a great deal of time. Your time is invested during the initial acquisition of the property, as well as throughout the life of the project. Passive investments are quite the opposite, requiring your time only up front while you research the best deal for your financial goals. Â
#3 – Degree Of Involvement
When considering active or passive real estate investing it’s important to ask yourself how hands-on you’d like to be? For instance, would you like to manage the property yourself, screening tenants, and overseeing maintenance, repairs and any improvements to the property? Or would you rather sit back and relax while someone else does all the heavy lifting?Â
#4 – Profit Distribution
As an active investor, you’ll most likely be the sole owner of the property, meaning any net profits would be yours to keep. Passive investors share the profits as they’re distributed among the many investors.Â
Be sure to keep in mind that how the profits are distributed doesn’t necessarily mean that one type of investment will net you higher returns than the other. To determine the best returns you’ll have to vet each deal and compare each deal to another.
#5 – Out Of Pocket Expenses
When unexpected costs arise, active real estate investors are responsible for supplying the additional funds. Emergencies, repairs and insurance claims all will likely require additional unforeseen money.Â
Passive investors get the luxury of making only their initial capital investment and never being responsible for any additional funds during the lifecycle of the project.Â
#6 – Your Risk and Liability
Active investors are held personally liable if a problem arises with the property. Being held liable means you’re at risk to not only lose the property, but your other assets as well.Â
With passive investing, your liability is limited to the capital you invest. The asset is usually held in an LLC or LP. If the deal goes south, the sponsors are held liable, not the passive investors. The passive investors only stand to lose the amount of their initial investment.Â
#7 – Expected Paperwork
The amount of paperwork involved in an active real estate investment is not for the faint of heart. There’s paperwork required from the initial purchase of the property throughout the life of the project. As an active investor, you can expect paperwork in the form of tracking purchase and rental agreements, bookkeeping, and legal documents, just to name a few.
However with passive real estate investments, you typically only have to sign a single PPM (private placement memorandum) to invest in the property. All other paperwork, such as lender paperwork, insurance and bookkeeping is all handled by the sponsor team.
#8 – Working With A Team
Active real estate investors are required to build their own team, including brokers, property managers, and contractors.
For passive investors, when you invest in a real estate syndication deal, the team is typically already established. You’re able to simply rely on the shared expertise of the existing deal sponsor team.Â
#9 – Opportunity For Diversification
Most active investors have limited knowledge when it comes to multiple markets and asset classes. In order to become an expert, or if you’re investing outside your local area, you would need to extensively research the market, find a “boots on the ground” team, and most likely visit the area.
Passive investors have a much easier time diversifying across different markets. You are partnering with sponsor teams that have already researched those markets and built strong local teams, so there’s no need for you to start from scratch.Â
#10 – Taxes And Bookkeeping
Active investors are responsible for their own bookkeeping, meaning that you’ll need systems in place to keep track of the income and expenses of the property. You’ll also need to hire a CPA to make sure that you are properly depreciating the value of the asset each year.
As a passive real estate investor, you’re not required to do any bookkeeping. You simply receive a Schedule K-1 every spring for your taxes, which shows the income and losses for that property. There’s no need for you to track income and expenses throughout the year.
Making Your Decision Between Active And Passive Investing
If you’re up for adventure and ready to dive right into the daily operations of a rental property, then you might have exactly what it takes to be a landlord. An active role in a real estate investment could be a perfect fit for your lifestyle and goals.Â
If your time is limited but you’d like to put your hard earned money to work for you, you might want to consider being a passive investor.
Maybe you’re looking for an opportunity somewhere in the middle. Perhaps, turnkey rentals and buy-and-holds may provide some control without the huge time investment.
Whichever path you choose, be sure to factor in your unique situation, goals, and interests.