Active Versus Passive Real Estate Investing… Which One Is Right For You?
Did you know you could invest in real estate without having to deal with tenants, toilets, trash and termites? It's true: you can reap 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 people think of real estate investing, they envision buying a single-family home, finding a renter, and collecting monthly rent income. Sounds simple enough, but the reality is quite different.
Even if a professional property management team is on board, you as the landlord must remain involved in the investment.
The property managers will handle the day-to-day issues, but you will still need to be involved in strategic decisions, such as whether to evict nonpaying tenants, file insurance claims when unexpected surprises occur, and sometimes have 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 passive - you never get calls from the property manager, you never have to screen tenants, and you never have to file any insurance paperwork.
However, being a passive investor implies that you give up some control over the investment and rely on someone else (i.e., the sponsor team) to manage the property and carry out 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, Toilets, Trash and Termites
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 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 it?
#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 from 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 yourself 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.
However, if your time is limited but have the capital to invest, you might want to consider being a passive investor.
If you’re hoping for a middle-ground option, turnkey rentals and buy-and-holds may provide some control without the huge time investment.
When determining which is the right path for you, be sure to factor in your unique situation, goals, and interests.
If you are investing in real estate already, how did you decide which path was right for you?
After reading this article, which option will you choose?