Did you know that you could invest in real estate without having to meet with tenants? Without having to fix broken toilets at 3 am? And without having to meet with brokers and property managers?
Sounds like a dream come true, right?
That’s exactly what I was thinking when I first discovered this thing called passive real estate investing. In this article, I’ll help you gain a better understanding of what it means to be an active or passive investor and how to decide whether you should invest actively or passively in real estate.
While most people believe that diversifying into real estate means buying rental properties and managing those active investments in an effort to create cash flow, active investing can quickly become a full-time job or a money pit, or a variety of other not-so-nice names I’ve heard before. Single-family rental property isn’t the only way to get your foot in the door as a real estate investor, but it turns out there are several commonly-believed misconceptions about becoming a real estate investor.
So, take it from someone who’s tested both active investing and passive investing, made the mistakes, and figured out the strategy and pros and cons of each – so you can completely skip the learning curve!
My Experience with Active Real Estate Investing
When I first heard about passive real estate investing through real estate syndications, I’d been investing actively in real estate for about ten years. In those ten years, my husband and I had scrubbed mold and grease off walls and cabinets, gotten on our hands and knees to lay tile, and used buckets to remove flood water from basement units. #joysofbeingalandlord
We put the “active” in active real estate investing!
When we moved from Washington, DC, to Vancouver, Canada, my husband, the kind of landlord who loves rolling up his sleeves and fixing things himself, decided he could do all the property management himself, from afar.
Yeah. Mm-hmm. I was shaking my head too.
Well, you can imagine what happened next. Two months went by, and everything sailed along, completely fine. Then, all in one week, DC experienced two massive storms, and everything went wrong at once for our real estate investments.
The next week? You guessed it, we had a property manager.
Still, even with a professional property manager to handle the ongoing property management and day-to-day issues for the commercial real estate properties, I still considered ourselves active real estate investors. We were still involved with tenant selection, lease renewals, decisions on turnovers and maintenance, and on and on. It was less hands-on than self-managing, but it was by no means completely hands-off.
My Experience with Passive Real Estate Investing
Fast forward to today. While we still have dozens of active real estate investments in multiple states that we own ourselves, either self- or professionally managed, my favorite types of real estate investments are now passive real estate investments.
These are the kinds of real estate investments where I can write a check to invest alongside other investors, and a team of professionals takes over the day-to-day operations, sending me quarterly dividends.
These are the “set it and forget it” investments of the real estate world.
Are the returns lower for passive real estate investors? Of course they are.
But the difference between active real estate investing and passive real estate investing is like cleaning your own house versus having a professional do it for you. You might save some money doing it yourself, but you’re putting in time and sweat equity, and the house may not be as clean as if a professional did it.
Now that I have kids, my time is much more valuable than the slightly higher returns I would get as an active landlord. I would much, much rather take my kids to the playground than review tenant applications. Passive real estate investments give me that time freedom I now value so highly.
Deciding Whether You Should Be an Active or Passive Real Estate Investor
Perhaps you’re on the fence as to whether investing passively in real estate is the right move for you. Maybe you’re curious about being a landlord and what active investing might look like in your life? Or perhaps you’d like to try your hand at flipping a property?
It’s also completely okay if you’re still in the early research phase of getting started with income-producing real estate.
I totally get it. There are a lot of things to think about, and deciding how best to invest your money and your time can be a tough decision.
Here are 10 things you should consider when deciding whether to become an active or passive real estate investor.
#1 – Tenants, Termites, and Toilets
The first thing you should consider is whether the words above – tenants, termites, and toilets – excite you or terrify you. If you’ve always wanted to become a landlord, and the thought of screening tenants, marketing your own property, collecting rent, and rolling up your sleeves to improve property are things that thrill you, then perhaps you should consider taking a more active role in your investments.
If, on the other hand, you don’t want to touch any of those with a ten-foot pole, then perhaps you should take a backseat and become involved in passive real estate investments.
#2 – Time
How much time do you have to devote toward your real estate investments? Actively managing investment property requires substantially more time, both during the initial acquisition as well as throughout the lifecycle of the project.
With passive investing, on the other hand, you do some upfront research and vetting, but once you passively invest, you do not need to put in any additional time.
#3 – Involvement
I used to love the hands-on nature of designing a kitchen rehab, picking out the finishes and patterns. I’m now at a point in my life when I’m happy for someone else to take the lead on those types of decisions.
As an active real estate investor, you get to choose those designs, vet tenants, and make decisions on renovations and upgrades. As a passive real estate investor, you put your trust in someone else to do those things.
Think of it like an airplane ride.
The active investor is the pilot. The passive investors are passengers.
Everyone on the plane is going to the same place, but their levels of control and involvement are very different.
#4 – Profits
With active real estate investments, because you are putting in the lion’s share of the time and work, you are also rewarded with the lion’s share of the profits. Passive real estate investors share a pool of profits.
However, keep in mind, that just because you are sharing profits with other real estate investors, that does not necessarily mean that your return on investment will be lower than if you were to invest actively. It all depends on each of your real estate deals, the market, loan terms, the business plan, and other aspects.
#5 – Expenses
Active real estate investors need to plan for ongoing, upcoming, and unforeseen expenses that could or might occur at each rental property.
If you’re actively investing, you might save some money each month for capital reserves and emergencies, but in the event that something bigger goes awry, you may need to put more money into the investment, and/or deal with insurance claims.
In most cases, as a passive real estate investor, your original investment is the only capital you’ll need to put in for the life cycle of the project. As a limited partner passive investor, when unforeseen circumstances come up and are not covered by the capital reserves or other buffer, you may see lower returns for a while, but it’s rare that you would need to put in additional capital.
#6 – Risk and Liability
Things are all well and good when tenants are happy, and your property is doing well. But what about when unexpected things pop up?
With an active real estate investment, depending on how you structure it, you could be held personally liable, and your tenants could come after your other assets, so it’s important to take steps to protect yourself and your assets (we recommend creating an LLC as a first step).
Every investment opportunity comes with a certain level of risk. Active investors carry most of this risk (aside from that alleviated by insurance) for each rental property in their real estate portfolio.
With a passive real estate investment, your liability is limited. You are investing in an LLC or LP that holds the asset, so your stake in it is limited to the amount you invest. If all hell breaks loose on the property, the worst-case scenario would be that you would lose your original investment; your other assets would not be in jeopardy.
#7 – Paperwork
As an active real estate investor, you should be prepared for a lot of paperwork, both during the investment process as well as through the bookkeeping, reports, and legal documents needed throughout the life cycle of the project.
As a passive real estate investor, you sign one document up front, then receive monthly email updates, quarterly financial reports, and an annual K-1. Passive real estate investing creates less work on all fronts of the real estate investing business.
#8 – Team
As an active real estate investor, you typically put together your own team. You choose the broker, property manager, and contractors you want to work with.
As a passive real estate investor, you invest in a team that’s already put together. The deal sponsor team will have already identified the broker and property managers they want to work with, so you leverage their shared expertise.
#9 – Diversification
This is one area where I think being a passive investor really gives you the upper hand. Because passive investing doesn’t take as much of your time, nor do you need to be hands-on, you can invest your money into more assets. Furthermore, those assets don’t have to be local, as you are leveraging the expertise of teams on the ground in each target market.
As an active investor, you must be an expert in whatever asset class and market you’re investing in, which takes time and energy, so your ability to diversify into multiple markets and multiple asset types will be limited. Passive real estate investing, on the flip side, can provide almost unlimited opportunities for diversification.
#10 – Impact
On the impact front, you should consider whether you want to have a broad or deep impact.
As a passive real estate investor, because you are able to invest in more assets and bigger projects, your money goes farther and has the potential to impact more people, families, and communities. However, your direct contact with those tenants is limited.
As an active real estate investor, you can have a deeper relationship with your tenants, if that’s what you desire. We have good friends to this day who started out as tenants in our rental properties.
The Real Estate Investing Spectrum
The good news is, if you’re not 100% sure whether you want to invest passively or actively, there are options in the middle as well.
If you’re ready to roll up your sleeves and manage your own fix-and-flip like an HGTV pro, you’re likely on the active end of the real estate investment spectrum. If you’re strapped for time and just want to put your money into an investment with stronger and more reliable performance than the stock market, you’re likely on the passive end of the spectrum.
But if you’re thinking that you might be in the middle, look into turnkey rentals and buy-and-holds, as they may give you some of that control and passive income without a huge time investment.
Should You Be an Active or Passive Investor? Take the Quiz!
If you’re on the fence, check out the quiz below to find out where on the spectrum you land. You can download a PDF version of the quiz here.
Investing in real estate is a great way to build passive income, create long-term equity, qualify for tax benefits, and have an impact on people and communities. Whether you invest passively or actively is up to you and your unique situation, goals, and interests.
Either way, there are investment opportunities aplenty out there for you, so you may want to try both ends of the spectrum.
If you’re interested in learning about more passive real estate investment opportunities, consider signing up for the Goodegg Investor Club, and we’d be happy to share our latest offerings with you, so we can partner together to change the world, one investment at a time.
