Did you know you can invest in real estate without the work of dealing with tenants, toilets, and termites? It’s true – you can get all the benefits of investing in real estate without the hassles of being a landlord.
In this article, you’ll see the difference between active and passive real estate investing so you can decide whether you should be an active or passive investor.
What Being an Active Investor Means
When most people think of real estate investing, they think of rental properties – buying a single family home, finding a tenant who wants to rent it, and collecting monthly rental income. It sure sounds easy enough, but believe me — the reality can be quite different.
Even with a professional property manager on board, you will still have an active role in the investment as the landlord.
The property managers may take care of the day-to-day issues, but you’ll still need to be involved in strategic decisions, including setting rents when advertising for new tenants, whether to evict tenants who aren’t paying, filing insurance claims when unexpected surprises happen, and sometimes having to put in additional funds to cover maintenance and repair costs.
What Being a Passive Investor Means
On the other hand, passive investments are “set it and forget it” types of real estate investments. You invest your money, and someone else does the heavy lifting.
The great part about passive investing is that, well…it’s totally passive! You don’t get calls from the property manager, you don’t have to screen tenants, and you don’t have to file insurance paperwork.
However, being a passive investor also means that you relinquish some 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 for you.
#1 – Landlording: Tenants, Termites, and Toilets
If you’ve dreamt of becoming a landlord, having tenants, and managing property improvements, then consider an active investor role.
However, if the title to this bullet point makes you want to vomit, passive investing may be a better fit for you.
#2 – Time
Active real estate investments are more time intensive, both in the initial acquisition and throughout the project lifecycle, while passive investments only require your time up front.
#3 – Personal 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 with contractors? Or do you want to sit back while someone else does all of that?
#4 – Risk and Liability
With active investing, it’s your name on the dotted line, most likely including guaranteeing the loan. So if things go south, you’re personally held liable…which means you may lose not just the property, but also your other assets.
With passive investing, your liability is limited to the capital you invest. You’re not on the loan, and the asset is typically held in an LLC or LP. If anything goes terribly wrong, the sponsors are held liable, not the passive investors.
#5 – Profits
With active investing, you’re probably the only owner of the property, so you get to keep all net profits. This doesn’t necessarily mean either type of investment will net you higher returns than the other; you’ll need to compare one deal to another.
With syndications, however, the profits are distributed among many investors. And when looking only at syndications, the active investors (sponsors) do make higher profits than the passive investors due to the amount of work they put in to make the project successful. Only fair, right?
#6 – Expenses
Active real estate investors should plan to handle insurance claims, emergencies, and repairs, which may require additional money at times, whereas passive investors only make an initial capital investment.
#7 – Diversification
With active investing, you’d personally 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’re investing with teams that have already taken the time to research those markets and build strong local teams.
#8 – Paperwork
Active investments are heavy on paperwork, from the initial purchase of the property to tracking rental agreements, contractor bids, bookkeeping, and legal documents throughout the project.
With passive real estate investments, on the other hand, you typically sign a single set of subscription documents to invest in the property when it’s being purchased. No need to fill out lender paperwork, file for insurance, or do any bookkeeping.
#9 – Team
As an active real estate investor, you need to build your own team, including brokers, property managers, and contractors.
As a passive investor, you rely on the shared expertise of the deal sponsor team. The sponsors are experts in the market and typically already have a team set up to manage the property.
#10 – Taxes
As an active investor, you’ll be responsible for the bookkeeping, meaning you’ll need to keep track of the income and expenses. You’ll also need to work with your CPA to make sure you’re properly depreciating the value of the asset each year.
As a passive real estate investor, you don’t need to do any bookkeeping. You receive a Schedule K-1 every spring, which shows the income and losses for the property, so you can do your taxes. But there’s no need to track the income and expenses throughout the year.
Conclusion
If you’re ready to roll up your sleeves and get busy with the various tasks of being a landlord, active investing might be a great adventure for you.
On the other hand, if you have capital to invest but your time is limited, you might want to consider being a passive investor.
If you’re hoping for a middle ground option, turnkey rentals and buy-and-holds are active investing strategies that may provide some control without the huge time investment.
BUT WAIT…..is it possible to do both active and passive at the same time? SURE it is!!
Many investors invest actively like doing single family flips or being a syndication sponsor while simultaneously investing passively in syndications to diversify and keep their money hard at work! In fact, combining these strategies may actually reduce the income taxes they’d owe on their active investments if that was the only avenue they were pursuing.
(Note: please consult your own CPA or tax advisor on your own unique tax circumstances.)
When determining which is the right path for you, be sure to factor in your unique situation, goals, and interests. And keep in mind you don’t have to choose one or the other – you may want to do both at the same time!
Further reading: Real Estate Syndications — Are They Right for You?
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