About 10 years ago, my husband and I bought our first home. Contrary to most people’s first home experience, we never bought, and still to this day have never owned, a single-family home. Instead, our realtor at the time floated the idea of purchasing a duplex, which is quite common in Washington, DC, where we were living at the time. DC’s many rowhouses often include an English basement or in-law suite on the bottom floor, complete with its own kitchen and separate entrance.
Someday, our realtor said, if we played our cards right, we might be able to get the property to be cashflow positive. In other words, the rent we brought in each month might surpass the mortgage we were paying. Wow, that sounds pretty good, we thought. Having tenants pay us to live for free? We were hooked.
From that first duplex on, we bought 28 additional units, all in small multifamily rentals. We managed some ourselves, but we hired a professional property management company for most.
Active vs Passive Real Estate Investing in Multifamily Properties
Small multifamily rentals certainly have some advantages over single-family homes, though they can still be a fair amount of work. In a multifamily, if one tenant moves out, the rental income from tenants in the other units is still there to help pay down the mortgage. Multifamily also allows us to leverage some economies of scale, though not much.
For example, for a fourplex, we have one roof to maintain versus four individual roofs for four separate homes. We are still involved when repair and maintenance issues arise, even if it’s just a quick nod of approval. There’s bookkeeping to be done, tenants to approve, and marketing to consider. As our investment portfolio has grown, we’ve found that owning a portfolio of multifamily homes is fairly hands-on, even with a property manager. It’s like running a small business.
Further, because we own small residential properties (versus commercial real estate properties), each property is market-dependent, meaning its value depends on comparable properties in the area. If a duplex down the street sells for $500,000, ours would likely be valued around the same, even if we can generate more income through our property.
As we’ve scaled up and added more properties to our real estate portfolio, I no longer believe owning investment properties is purely a passive income investment, like investing in stocks. Instead, I see it more as a small side business. Sure, there’s not much steady day-to-day work, but we’re still involved in the operations and major decision-making.
What Is Passive Real Estate Investing?
Passive real estate investing is when you put in the capital upfront and then sit back and collect on your investment monthly. This allows you to earn money without all the time and energy of actually owning your own real estate investment. As a passive real estate investor, you collect passive income without being a property owner and/or landlord. Sounds great, doesn’t it?
Now imagine having multiple passive real estate investments and benefiting from those passive income streams every month. With the right investment strategy, you could eventually replace the income from your job and live the life you’ve always wanted.
Different Real Estate Investment Types For Passive Income
There are several different types of passive real estate investing opportunities. The most popular ones are real estate investment trusts (REITs), real estate crowdfunding, and real estate syndications.
Real Estate Investment Trust (REIT)
Real estate investment trusts generally focus on a particular real estate sector, like apartment buildings, storage space, or office buildings. They are designed to work like mutual funds do, offering individual investors the opportunity to pool their funds together as a passive real estate investment.
With REITs, you are investing in the company that manages the real estate investments, and not the actual real estate; therefore, you are taxed on your profits and dividends as ordinary income without the tax benefits of owning a property. These types of real estate investments allow your cash to be liquid, meaning you can invest or withdraw your money at any time, similar to stocks.
Crowdfunding Real Estate Ventures
Real estate crowdfunding also allows individual investors to pool their money together as a form of passive real estate investing. Crowdfunding uses artificial intelligence and algorithms to match investors who sign up on the platform with properties that fit their investor profile.
While anyone can sign up for a crowdfunding site and browse the passive real estate investing options available, the success rate is low due to frequent failures to meet minimum investment goals. Fees and upfront costs tend to be high, and the online community has its share of scams, which makes it difficult to find legitimate investment deals. As with any investment, it’s imperative you investigate the company, their history, client reviews, and the success rates of their latest offerings.
Passive Real Estate Syndications
Real estate syndications exceed other potential forms of group real estate investing simply because of their transparency and available benefits. Instead of investing with a faceless company in a group of properties you may or may not be familiar with when you passively invest in a commercial real estate syndication, you know exactly what you’re investing in, the metrics around the potential returns generated, and exactly who you’re investing with. The top four benefits to investing in a real estate syndication are as follows:
First, you get to vet the syndication sponsor – you have several opportunities to get to know the sponsor and any other partners involved, their track record, and their strategy to optimize returns for their accredited investors.
Second, you get to take advantage of tax write-offs through property depreciation. You won’t have to do any extra paperwork or track expenses since the syndication sponsor does all that. You’ll get a K-1 to include with your tax filing each spring.
Third, real estate syndication investments require a longer investment period, usually 5-7 years, and provide greater opportunity for returns on your initial investment. Your investment capital is illiquid during this time as it fuels renovations and management costs on your investment property. 5 years is an excellent length of time to lock away your money, but not so long that your kids will be graduated from college before it’s available again!
Finally, after you’ve performed the initial research on the syndication and submitted your investment capital, you carry no further responsibility or liability. All you have to do as a passive real estate investor is collect the passive monthly income generated from the syndication. There are no contractors to coordinate with or tenants to screen – it’s truly passive income!
More on the benefits of passive real estate investing below.
Five Reasons Real Estate Syndications Are The Best Form Of Passive Real Estate Investments
After being enlightened on the advantages of truly passive real estate investments through syndications, we shifted our portfolio and our strategy from active real estate investments toward passive real estate investing.
These are professionally managed and operated investments where we can write a check, sit back, and generate passive income. No tenants, toilets, or termites to deal with. According to Forbes, once real estate investors begin to understand passive commercial real estate investments, it’s not uncommon to see them move away from owning small rentals to re-deploy their capital across several larger deals.
Here are the top five reasons we love investing passively in real estate syndications and why you should invest in them too.
1. You Don’t Have To Put In Much Time.
Investing in real estate passively means you put your money in, see monthly cash flow payouts during the life of the investment, and get a share of the profits upon the sale of the property. It’s a “set it and forget it” type of real estate investment.
You don’t need to be actively involved. You don’t need to drive to the property to fix toilets in the middle of the night, screen tenants, or deal with maintenance requests. The deal sponsor and property management team are the experts who will take care of all of that, so you can sit back, enjoy the returns, and focus on living your life.
2. You Get To Diversify Your Investment Portfolio.
It takes a LOT of time to become an expert in a market, particularly when it’s not in your backyard. By investing with an experienced deal sponsor with a proven track record, you can leverage their expertise in improving the asset and diversify into different markets and asset classes with assurances the professionals are taking care of the business.
3. You Get Pass-Through Tax Benefits.
Just like the tax advantages of investing in personally owned rentals, you get similar pass-through tax benefits when investing in real estate syndications. This means you will most likely show paper losses, even while receiving ongoing cash flow distributions. Often, this can mean you can defer taxes on this residual income until the asset is sold and the depreciation recaptured.
4. You Limit Your Liability.
On a personally owned investment property, if things go south, guess who’s on the hook? You guessed it, it’s your bank account and other assets on the chopping block. When you invest passively through a real estate syndication, however, your liability is limited to the amount you invest. If you invest $50,000, your biggest risk is losing that $50,000, but you can’t lose anything beyond that (which, I totally get, is still a huge amount). You are not on the hook for the entire property value, and any other assets you own would not be at risk.
5. You Get To Make An Impact.
This is perhaps our favorite part of real estate investing, especially in commercial real estate syndications. Whereas with our personal investments with duplexes or quadplexes, we’re making a difference in two to four families, with a real estate syndication, we have the opportunity to scale our impact, to change the lives of hundreds of families and whole communities. Each syndication we invest in creates a cleaner, safer, and nicer place to live and brings a positive impact on the community and to the environment. That’s something you just don’t get from other types of investments, like stocks and mutual funds.
Still Deciding How to Get Involved with Passive Real Estate Investing?
If you’re on the fence about whether you should invest in a small active real estate rental property or passively invest in a real estate syndication, I can tell you that owning small rentals can be a very valuable experience. We’ve certainly learned a TON over the years through owning our own rentals. However, owning rental properties is not a prerequisite to investing passively in commercial real estate.
If you have plenty of time on your hands and can’t wait to roll up your sleeves and experience owning your own rental property, there’s nothing like it, and I heartily support you. On the other hand, if you’re not interested in learning the ins and outs of real estate, feel short on time, and can’t imagine managing all the moving parts of your own rentals, a passive investment might be the way to go.
If you’re still conflicted, check out our Active vs. Passive Investing Quiz. Either way, investing in real estate is a great way to diversify your real estate portfolio and mitigate risk. It allows you to have a positive impact on families who will live in your units, as well as a positive impact on the environment and community.