A question I get asked quite often is: “I want to start investing in real estate, but how do I know which is better, active investing or passive investing?”
Let’s first look at active vs. passive real estate investing to understand the main differences between the two.
Active investing is when you personally buy a property.Active investors are involved in every aspect of the deal: from identifying the right market, finding the property, obtaining financing, personally guaranteeing the loan and managing the investment.
Passive investing is a hands-off approach which allows investors to place their capital into a real estate syndication that is managed entirely by a sponsor.Investing passively means you relinquish control, as the sponsors are responsible for buying and financing the property, executing specific business plans, and running the day-to-day operations.
Whether you should be an active or passive real estate investor is a personal decision, and you should consider a few things when making this decision.
Start with Why
First off, start with “why.”Ask yourself this question and answer honestly: Why do you want to invest in real estate?
Having a why will help you focus your goals and direct how you invest your money.
For me and my husband, we invest in real estate to:
1.Have more time for ourselves and our family
2.Be able to practice medicine as much or as little as we want to
3.Make an impact and be purpose-driven with our investments
We’ve found passive real estate to be the best investment class in achieving our above goals for the following reasons:
1.Passive real estate investing allows us to be completely hands-off.I’m busy seeing patients all day, operating on people’s eyeballs, picking up and dropping off my daughters at school, driving them to their activities….I really don’t have alot of free time.With passive investing, I’m able to participate in real estate but keep my precious free time.
2.I get monthly cash-flow coming in without doing any work.Over time, this passive income adds up to replace some, and (hopefully) eventually all of my active income.Then the choice of how much to work is entirely up to me.
3.Like everyone else, I want to make a good profit on my investments.But I also want to put my money where my values are.With real estate, I can get good financial returns while also making a positive impact — the residents living in the apartments, the surrounding community and neighborhood.As a passive investor, I get to invest responsibly and profitably.WIn-win-win for everyone.
So I would challenge you to start with listing out your reasons for wanting to invest in real estate.This will help guide how you want to invest.
Now let’s talk about five things you want to consider when deciding whether you want to be an active or passive investor.There are risks and benefits associated with both approaches, and you should consider them and choose the option that is most suitable for your lifestyle and investment preferences.
Five things to consider when deciding whether to be an active or passive real estate investor
#1 – Time
No one can argue that time is our most valuable resource.You can’t generate more it, and once time passes, you can never get it back.
Ask yourself: 1) how much time do you have, and 2) how much of that time do you actually want to devote toward real estate?
Actively investing in real estate will require a significant time commitment, from finding, financing, and purchasing the asset to managing the property after closing.
Active investors become landlords, which can be grueling and time-consuming.First, you have to educate yourself on the particular asset class you’re investing in, then you have to find your team members (broker, property manager, account, attorney, etc), and then you have to find, qualify and close the deal.After closing the deal, the work doesn’t end.Even if you outsource property management, you’re not completely hands-off.You’re still responsible for making decisions and fixing problems.
As a busy doctor with a job to do or a business to run, you might not have that time (or don’t want to spend your free time) being active in real estate.
Passive investing is more or less hassle-free.Once you’ve vetted the sponsor and the deal, and invested your capital, no additional time is required.
#2 – Control
I used to love watching Chip and Joanna on HGTV and seeing how they designed the kitchens and picked out finishes.
When I first started investing in real estate, I was so excited about being able to rehab properties and choose the flooring, tiles and countertops.As an active investor, you’re able to make all those decisions and more (such as the level of renovations to perform, deciding on rental rates and qualifying tenants, and when to refinance or sell a property).You have complete control over the business plan.
However, at this point in my life, I’m busy taking care of patients, spending time with my husband and kids, hosting playdates, and potty training my younger daughter…that I’m more than happy to let someone else take the reigns on these decisions.
As a passive investor, you provide only capital and are not involved in the day-to-day operations and management of the property.When you give up control you’re also putting alot of trust into the sponsor and their team to execute the business plan (thus the importance of vetting the sponsor and doing proper due diligence).
#3 – Risk
There is risk to both active and passive real estate investing.With active investing, the risk is concentrated entirely on the person who purchases the property.Buying properties directly means you guarantee the loan and can open an investor to unlimited risk exposure.But higher risk typically equates to higher upside potential.You get 100% of the profits, but also have to bear the potential for 100% of the losses.
With passive investing, you are exposed to much less risk. The risk is still there, but it is spread across multiple parties.If something goes wrong, you won’t be the one solely responsible for identifying and funding a resolution.So overall, there is less risk for any one individual with passive investing.
#4 – Returns
As an active real estate investor, because you are putting in the time and work, you are alsopotentially rewarded with more of the profits. As a passive real estate investor, you will be sharing your profits.
However, keep in mind, that just because you’re sharing the profit in passive investments, it does not necessarily mean that your returns will be lower than if you were to invest actively.It all depends on the individual deal.In fact, some of my best real estate investment returns been with from passive deals.And some of my most active deals have cost me money.
#5 – Diversification
In my opinion, passive investing wins in this category. As a passive investor, you can truly diversify your investments over different real estate asset classes, geography and sponsors.
It’s harder to achieve diversification as an active investor because you have to spend time being an expert in your particular market and asset class.Most active investors stay in their local market for this reason.But are the best deals in the country only within 20 miles of where you live?Probably not.In addition, as an active investor, you’re putting a larger portion of your capital into one particular deal (vs. investing smaller amounts and being spreading out your money across multiple deals).
Conclusion
In the end, there are many ways to invest in real estate.It’s important to understand the pros and cons of each, and to identify whether being an active or passive investor is best for you.
For those with time, access to deals, and a solid team, active real estate investing may be the right choice.If you’re a busy professional with limited time, then partnering with an experienced sponsor and passively investing is a great way to generate passive income with minimal effort.
