Active Versus Passive Real Estate Investing – Which One Is Right For You?
Did you know you could invest in real estate without having to worry about tenants, toilets, or termites? It’s true: you can experience all of the benefits of real estate investing without having to deal with the headaches of being a landlord.
In this article, you’ll see what passive real estate investing means and find out if you should be an active or passive investor.
What It Means To Be An Active Investor
When most individuals think of real estate investing, they imagine buying a single-family home, finding a tenant, and collecting monthly rent income. Although it appears to be simple, the reality might be quite different.
Even if you hire a professional property management company, you will still be involved in the investment as the landlord.
Although the property managers will handle the day-to-day issues, you will need to be involved in strategic decisions such as whether to evict non-paying tenants, filing insurance claims when unexpected expenses arise, and occasionally having to put in additional funds to cover maintenance and repair costs.
What It Means To Be A Passive Investor
On the other hand, passive investing refers to real estate investments that are “set it and forget it.” You put your money in, and someone else does all the work.
The best part about passive investing is that it is completely hands-off — you won’t receive calls from the property management, you won’t have to screen tenants, and you won’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 on the business plan on your behalf.
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, and Toilets
Consider taking on an active investing position if you’ve ever wanted to be a landlord, have tenants, and make renovations. We host a monthly real estate meetup called Windy City REI that helps educate others on the various nuances related to active real estate investing.
Otherwise, if the title to this bullet point makes you queasy, you should consider going 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, deal with tenant requests, and schedule maintenance and repair appointments? Or would you prefer 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 all the net profits would be yours to keep. 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.
Conclusion
Active investing could be the perfect adventure for you if you’re willing to roll up your sleeves and get engaged in all elements of being a landlord.
However, if your time is limited but you have capital to invest, you might want to consider being a passive investor.
If you’re looking for a medium ground option, turnkey rentals and buy-and-hold properties may offer some control without a significant time commitment.
When determining which is the right path for you, be sure to factor in your unique situation, goals, and interests.