Real estate is diverse and you can decide how much effort, energy, and time you want to spend on investing depending on your goals and lifestyle. The majority of us are familiar with the popular fix and flip shows. While that looks like it can be a lot of fun for those who are interested in rolling their sleeves up, the reality is that a lot of people don’t have the interest or time to do that kind of work.
Most people have busy jobs or careers and it can be intimidating to get started in real estate investing. We are most familiar with high effort and high capital opportunities. It can also be relatively high risk and require skill that may seem out of reach. But what most people don’t know, is that you can still invest in real estate and choose how much time and effort you want to put into it. You don’t have to sacrifice your time to get into real estate and the capital required doesn’t have to be as sizable as a down payment on a first residence. I live in NYC and for those of you in this or other expensive markets, the cash to close on a small house or apartment can exceed $500,000.
My first investments in real estate were known as turn key single family homes that I rented with the help of a management company. Turn key properties are bought ready to rent and generally need no additional renovations or work to make the home rent-ready. On the other end, I helped my dad fix and flip houses growing up. Some he sold after fixing up and some he rented out and self managed. The same asset class, single family homes, but ultimately a very different level of effort.
In this post we will go over the main differences between passive and active investing in real estate and the type of investments available in both. Active investing requires you to spend time and effort to manage the investment, while passive investing does not require as much work. Investing in real estate is not necessarily just one or the other, but it is more of a spectrum.
Active Investing
Active investing is often being the landlord where you are managing the day to day tasks. An example of this type of investment is owning a house that you rent. You are responsible for finding tenants, hiring contractors to fix any issues that arise, securing a loan to purchase the property, evaluating the investment to decide if you should sell or refinance, etc. One way to reduce some of these responsibilities is to hire a management company which deals with some of these tasks but at the end of the day you are actively managing them and the investment.
Another type of active investing is fixing and flipping houses. This requires a lot of intensive work to acquire a house that needs major renovations, managing contractors, then selling at the end of the cycle for a profit. This can be risky because unforeseen circumstances can make repairs a money pit and the profit at the end is far from guaranteed. Oftentimes, more capital is required up front because banks won’t do long term mortgages on properties in rough condition. You’ll need to secure funds to purchase and renovate the property. Generally, fixing and flipping also requires you to pay short term capital gains instead of long term, which is a higher tax rate.
Active investing can be profitable but it requires education, time, and experience. It is possible to make a large profit because you are also putting sweat equity into it and taking on higher levels of risk.
Passive Investing
In this category are real estate investments that don’t require much of your time or effort to realize returns. You are not the person that manages the asset or the day-to-day interactions with the tenants. You don’t need to be an expert in real estate.
These investments come in different flavors and some have more benefits than others. Some of them I’m sure you have heard of and some may be completely new to you.
Real estate syndication
A real estate syndication is bringing together capital from multiple investors to buy a single asset. This makes large investments more accessible to individual investors.
In a syndication, there are 2 groups, the General Partners (the active investors) and the Limited Partners (the passive investors). Benefits to this is that the investment is truly passive for the limited partners. Once the passive investor decides this is a deal they want to get into, they sign a contract, wire the funds, and become part owner of a real estate asset. Most of the time, the structure allows for the passive investor to receive real estate benefits similar to owning a property solo. For example, depreciation of the asset can offset cash flow gains.
Real estate funds
Real estate funds raise capital to acquire multiple properties. The investors typically don’t have insight into what properties will be acquired before they make the investment. These can have the benefit of being easier to get in and out of as compared to a syndication investment, but often have lower returns than a syndication because there is more overhead to running the fund. Funds often have more fees compared to syndications.
Real Estate Investment Trusts (REITs)
Most REITs are publicly traded like stocks so they are probably the most liquid way to get into real estate. They are also the most like a black box–the actual physical assets that are behind the REIT are not transparent. It is unclear what you’re getting into and what your investment really is. REITs sound like investing in real estate because the assets behind them are real estate properties. But, they don’t hold many of the benefits traditionally found in real estate. Yes, real estate is the underlying asset which performs well over time, but the way they are structured limits the other benefits normally seen in real estate. The gains in REITs are taxed as traditional income and don’t qualify for writing off depreciation. [1] Some have high management and transaction fees compared to other more direct methods of investing in real estate.
I’ve highlighted a few different active and passive ways to get into real estate. When choosing an investment, it is important to understand if it fits in with your goals. Ultimately, the type of investment you choose depends on how much time you have and your desired outcome. Personally, I invest in both passive and active opportunities as there are benefits to both.
Passive investing can create passive income which over time can add up to replace part or all of your income required to become financially independent. If you are interested in learning more about passive investing and creating passive income, schedule a call with us!