Active Versus Passive Real Estate Investing – Which One Is Right For You
I consider myself one of the lucky ones - my family has a strong history in commercial real estate. But most people, when they decide to venture into the world of real estate investing, think that buying a small rental property and being a landlord is the key to getting started.
While I have and enjoy managing a few short-term rental properties of my own, most people make the mistake of accumulating one rental property after another until they’re nearly overwhelmed by the hassles of being a landlord.
Here at DIG Capital, we firmly believe that investing shouldn’t be another full-time job. So I’m here to share that you can invest in real estate without the headaches of tenants, toilets, and termites. Imagine a life in which you have the opportunity to invest in real estate without any of the hassles of being a landlord. Well, it does exist!
In this article, you’ll see what passive real estate investing means and find out whether you should be an active or passive investor.
Active Investing - What It Really Looks Like
When most people think of real estate investing, they think of rental property investing – buy a single-family home, find a renter, and collect monthly rental income. Sounds easy enough, but the reality can be quite different.
Even with a professional property management team on board, you as the landlord still have an active role in the investment.
The property managers may take care of the day-to-day issues. However, you will still need to be involved in strategic decisions, including whether to evict tenants who aren’t paying, filing insurance claims when surprises happen, and sometimes having to put in additional funds to cover maintenance and repair costs.
Passive Investing - What It Really Looks Like
Alternatively, I’m excited to introduce you to passive investing, which is more like “set it and forget it” real estate investments. You invest your money, and the general partners do all the heavy lifting.
The significant 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.
However, 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 the business plan on your behalf.
Should You Be an Active or Passive Real Estate Investor?
Here are ten factors to help you decide which path is right for you.
#1 – Tenants, Termites, Toilets, and Calls at 3 AM
If you’ve dreamt of becoming a landlord, having tenants, and making improvements, then consider an active investor role.
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 upfront 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 have someone else do 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 the property and 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.
On the other hand, with passive real estate investments, 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 need to be an expert in the market and asset class in which you’re investing. If you’re investing outside your local area, you 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. Instead, 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 correctly depreciating the asset’s value 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.
Is Active Or Passive Investing Best For You?
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.
However, if your time is limited but you have the capital to invest, you might want to consider being a passive real estate investor.
If you’re hoping for a middle ground option, turnkey rentals and buy-and-holds may provide some control without the considerable time investment.
When determining the right path for you, strongly consider your unique situation, goals, and interests. Either way, I encourage you to do your research, find a mentor, and ask tough questions, so you’re fully informed and can make decisions in alignment with the lifestyle and goals you aim to achieve.
There are numerous risks with owning physical real estate via private placements including weather and natural disaster risks, interest rate risk, operator and business risks, and overall real estate market volatility which can effect the performance of the investments. Investing in private placement securities entails a high degree of risk, including illiquidity of the investment and loss of principal. Please read the offering document before investing.
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