As a kid, I enjoyed the adventurous lifestyle of moving around the western United States – from Idaho, Colorado, Arizona, to Alaska – my parents always jumped on an opportunity to move to new places so my siblings and I could experience what life was like in each different location.
With all my experience in different homes and living arrangements, it made sense for our family to establish a new construction company where our adventures took us. Being part of a growing successful company provided the realization of the positive impact available by combining real estate and business.
Then after a few years, I began craving a fresh challenge, and since I was always good with numbers, decided to go the engineering route. Each move came with a certain level of prestige and extra income, but I couldn’t shake the feeling that I was destined for more.
When a colleague of mine introduced me to house hacking, I just had to get into real estate myself.
As a rental property owner, I had to find tenants, do all the paperwork, and manage the property. This added hours of work to my already-busy weeks, which seemed in direct contrast with the passive lifestyle rumors.
I enjoyed the excitement and the income, of course, but I still wanted the ability to create and enjoy an adventurous lifestyle with my family.
Owning rentals helped me quickly realize the difference between working on and for real estate and being the owner/managing partner of real estate.
This began my search for truly passive real estate investing. Passive being the key word, I embarked upon a journey to find out how one could enjoy the benefits of owning real estate – passive income, tax advantages, and appreciation – without the struggles of being a landlord.
Spoiler alert – I found it!
In this article, you’ll find out what passive real estate investing means and discover whether 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 think of rental property investing – buy a single-family home, find a renter, and collect monthly rental income. Sounds easy enough, but the reality can be quite different, which I experienced firsthand.
Even with a professional property management team on board, you, as the landlord, still have an active role in the investment.
The property managers may take care of the day-to-day issues. However, you will still need to be involved in strategic decisions, including whether to evict tenants who aren’t paying, filing insurance claims when surprises happen, and sometimes having to put in additional funds to cover maintenance and repair costs.
What It Means To Be A Passive Investor
On the flip side, you have passive investing, which is the “set it and forget it” type of real estate investment. You invest your money, and someone else does all the heavy lifting.
The great part about passive investing is that it’s totally passive – you don’t get any calls from the property manager, you don’t have to screen any tenants, and you don’t have to file any insurance paperwork.
However, being a passive investor also means you relinquish some of your control in the investment and trust someone else (i.e., the sponsor team) to manage the property and execute 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.
#1 – Tenants, Termites, Toilets, and Calls at 3 AM
If you’ve dreamt of becoming a landlord, having tenants, and making improvements, 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 upfront 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 all of that?
#4 – Profits
With active investing, you would likely be the only property owner, so you would get to keep any net profits. With passive investing, the profits are distributed among many investors.
Investing this way doesn’t necessarily mean that one type of investment will net you higher returns than the other; you’ll need to compare one deal to another.
#5 – Expenses
Active real estate investors should plan to handle insurance claims, emergencies, and repairs, which may require additional money at times and additional work hours, whereas passive investors only make an initial capital investment and have no extra work hours.
#6 – Risk and Liability
With active investing, if things go south, you are personally held liable, which means you may lose the property and any other assets in which you have invested.
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 need to be an expert in the market and asset class you’re investing in. If you’re investing outside your local area, you 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 you will need to keep track of the income and expenses. You’ll also need to work with your CPA to ensure that you correctly depreciate the asset’s value 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.
Passive Vs. Active, Making The Decision Easier
So which type of investment is right for you? It’s ok if you don’t know which investment is the right choice right now; it can be a tough decision. Start by considering your unique situation, family needs, goals, and interests.
If you are ready to roll up your sleeves, fix some toilets, call in an exterminator when needed, and do other household tasks, (or, if you don’t mind hiring a property manager to help run your rental properties) active investing may be the adventure you want to take.
However, if you are looking for a little more adventure in your life and don’t want to be tied down locally as a landlord but have the capital to invest in real estate, consider becoming a passive investor.
There is even a bit of a middle ground option if you’re looking for the best of both worlds. You could try turnkey rentals, and buy-and-holds may give you some control without the huge time investment of being a landlord.
No matter the route you choose, when you invest in real estate, you’re making a positive choice toward diversification, recession-resistant assets, and an investment in the community. If you’d like to run anything by someone who’s also had various types and sizes of rental real estate, I’m always available!