Real estate investing is not as difficult as you might be led to believe. Now, that’s not to say that it’s easy, but with some time and a little hard work, it’s definitely something that’s within reach.
Thanks to the popularity of home improvement channels and DIY blogs, a lot of people may see real estate investing as someone with a lot of money to spare buying and flipping houses to sell for huge profits. It’s no wonder people are wary of real estate investing – who has the money or time to buy a run-down property, hire contractors and interior designers, then wait for the work to be done and the property to be sold?
But this isn’t the only option. For one thing, real estate investing is for anyone, not just the exceptionally wealthy. There are multiple ways to get started, no matter what your income, risk tolerance, or abilities. Whether you already own a property or two and want to take things to the next level or are looking for a way to eventually leave behind your nine-to-five job, real estate investing is a viable option. You just need to put in the work. That said, there are two main avenues to consider before jumping in: active and passive real estate investing.
What is Active Real Estate Investing?
Active real estate investing is when you purchase a property intending to sell it for profit or use it to generate rental income, or active income. This can be any kind of property, including single-family homes, duplexes, or larger multi-family dwellings. As an active investor, you’re involved hands-on in every part of the deal, including finding a property to buy and securing financing.
An active investor personally guarantees the loan and manages the investment so there is a higher amount of risk involved. That said, the right property in the right market at the right time can result in a pretty hefty return on investment.
Flipping houses is an extreme example of active real estate investing. Do you have to completely renovate a home by tearing down walls, loading it up with all new appliances, and landscaping the entire front yard? No. Sometimes, it can be as simple as patching a few holes, repainting, planting some flowers, and waiting for the right buyer. Either way, active real estate means you’re calling the shots and making every decision.
What is Passive Real Estate Investing?
Passive real estate investing is completely hands-off. If you have some extra money and want to get into real estate but you don’t have a lot of spare time, passive investing is a good choice. It’s also something to consider if you have other rental properties and tenants to work with and you want to invest more but know that you don’t have the time to care for another property.
Passive real estate investment involves putting money into a real estate-based mutual fund or trust. If you have a lot of money to invest, you may even be able to get into a private equity group or other syndicate involved in private investments and placements.
These funds can be used for residential or commercial properties or they can focus on buying property liens or mineral rights. A lot of passive investors put their money into a large syndicate, like an apartment complex or mobile home park, that is then managed by a sponsor.
In passive real estate investing, you have no say in the properties being purchased or any of the details. The plan sponsor is responsible for buying and managing an entire portfolio of properties, making sure things run smoothly every day, and then reporting back to the investors. This type of investment strategy is ideal passive income for many due to the fact that a lot of the ‘work’ behind property management is not taken on by the investor.
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Active vs. Passive Real Estate Investing
If you’re thinking about getting into real estate investing, there are five factors to consider when trying to determine whether active or passive is the right approach.
1. How much time do you have?
It’s no secret that active investing takes a lot of time. If you plan to sell the property, you have to put in all the work of fixing it up and getting it ready. Even if you’re not doing the work yourself, you still have to hire contractors and designers and make sure everything gets done on time.
If you choose to rent out the property, you become a landlord. That involves collecting rent and making sure general care and maintenance are done plus you have to be available for your tenants. If you’re handy with tools and choose to do the work yourself, you have to make time to go to the property and do repairs. If not, you still have to get on the phone with the plumber, electrician, or any other contractors you need to take care of the problem.
Passive investing doesn’t require any of this. You don’t have to worry about being a landlord or even being available. After you choose a sponsor and work out the initial agreement, all you have to do is take a look at your monthly or quarterly statements to see how your investment is performing.
2. How can you get the best deal?
Finding the right property in the right place at the right time is a skill that not a lot of people have. With passive investing, you essentially give your money to someone who has a track record of being able to find good deals. If you choose this route, do your due diligence. Choose a sponsor that comes highly recommended and has experience in what you’re looking to invest in. They have entire teams dedicated to finding the right investments and it’s a safe bet that you’ll end up with a good deal.
If you’re interested in active real estate investing, this part of the process takes a lot of work. You need to be familiar with the neighborhood you’re buying in and know where and when to look for the best properties at the best price. You should know what people want who are looking to move into the area. Of course, you’re not going to do this alone. A skilled realtor can help you with all of these things, particularly one who is intimately familiar with the neighborhood. But paying a realtor costs a lot of money, especially for a buyer, so you’re going to be out some of your initial investment right off the bat.
3. Do you want to diversify?
One of the big perks of passive real estate investing is it’s much easier to diversify. When you invest money into a large real estate fund, you’re a small part of a much bigger deal. There are funds from multiple investors lumped in with yours and the sponsor represents your collected interests. Because this kind of thing is their specialty, they may be able to invest in deals that are in the next town, city, or state. You have a lot of opportunities to benefit from good deals and potentially walk away with a healthy profit.
On the other hand, if you’re the type of investor who wants to own a few pieces of local real estate, active investing is the way to go. Understand that this is going to limit your options somewhat – you’re not going to be able to do a lot of hands-on work unless the property you’re investing in is somewhat local – but it also means you’re not at the mercy of the sponsor’s decisions.
There are other things to consider when it comes to diversity, too. Passive real estate provides an opportunity to get in on a wider range of investments. The chances of you being an active investor in, say, an office building, strip mall, industrial park, or multi-unit apartment building are pretty slim. Not only would you need a lot of capital to purchase one on your own, but the upkeep and management would require hiring and managing an entire staff, including housekeepers, a grounds crew, janitors, and more. If you’re a passive investor, though, there are a lot of opportunities here. In fact, some of the most reliable real estate investments are only accessible through passive investing.
4. Are you risk-averse?
As you might have guessed, active investing carries a lot more risk for a real estate investor. For one, you’re shouldering all of the financial responsibility. This alone opens you up to a lot of exposure. That said, the financial returns on an active investment are significant. You own 100 percent of the deal so you get every penny of the profit.
With passive investing, you’re putting your money into a system that’s already been proven to work. Hopefully, you’re working with a skilled sponsor who can navigate the management of the property as well as buying and selling within the fund to deliver a successful deal. The downside is that profit is split multiple ways. It’s shared between you and all the other investors. The sponsor also gets a cut and there are always fees and other expenses to cover.
5. How much control do you need?
Control is perhaps the biggest difference between active and passive real estate investing. If you’re a passive investor, you don’t really have control over anything. You entrust your investment to the sponsor and rely on them to make the right decisions with your money.
This is why it’s so important to make sure you’re working with someone you trust. Don’t just blindly hand your money over to a fund. Vet the sponsor thoroughly so you know that you can trust them and that their interests align with yours. One way to ensure that they’ll work with your interests in mind is to set up the contract with a preferred return. That means that you and the other investors receive a previously agreed upon return on your investment before the sponsor gets anything. This provides a financial incentive for them to get as large a return as possible.
If you’re an active investor, everything is in your hands. You decide what investments to go after, which to leave behind, when to buy in, and when to opt-out. If you’re selling the property, you determine when the market is right, work directly with the realtor, set the selling price, and negotiate. If you’re renting out the property, you screen the tenants, determine the rent, and either act as the landlord or pay someone to take care of the property for you. And, even if you hire someone to manage the property, all decisions ultimately fall to you.
Which is the right option for you?
There’s no straightforward answer as to which approach will work best for you. This is a very personal decision. You have to consider not only how much time and money you’re willing to invest but also which approach better suits you, your personality, and your lifestyle.
If you have a full-time job and you’re looking to get into real estate investing, you might not have the time required to take on the role of landlord. Partnering with a syndicator and investing in a fund managed by a sponsor has a lot of benefits and can deliver significant rewards.
On the other hand, if you’re ready to take on a more hands-on role and have some time to spare, active real estate investment is, in most cases, much more lucrative. Yes, you’re taking on a lot of risks but there’s also a lot to gain. If you flip a property and plan to sell it, you can walk away with a significant amount of money. There’s also the option of renting out the property and acting as a landlord. If you have the time and a little bit of skill as a handyman, this can be a great way to build a full-time income. By carefully choosing tenants and reinvesting your profit into more properties, in the end, your investment could end up paying for itself.