The Pros And Cons Of Active And Passive Real Estate Investing

by | Oct 18, 2021 | Uncategorized | 0 comments

Beginning real estate investors often start active real estate investing by buying one rental property after another. They directly manage the properties and, whether on purpose or accidentally, fulfill the role of landlord. 

Over time though, the hassles of being a landlord create unnecessary stress and can lead to major burnout. Trust me, I tried that with duplexes and our old condo.

If you’re interested in investing in real estate, but leery of becoming a landlord, I’ve got great news for you. Passively investing in real estate syndications allows you to become a real estate investor without taking on the added responsibility of becoming a landlord.

If you’re hoping to discover a way to generate truly passive income so you can continue to work, enjoy your family, and make money without an additional time commitment, you’re in the right place! This article breaks down active vs. passive real estate investing so you can determine the best route for you to become a real estate investor.

A Day in the Life of an Active Investor 

Rental property investing is the most commonly known type of real estate investment. You buy a single-family home, find renters and collect rent each month. That’s passive income, right?

Not so fast, this type of investment typically becomes much more active than originally anticipated.

Even if you hire a property management team, you’re still the landlord. Being a landlord requires you to take on an active role in the investment.

Your property management team can take care of the day-to-day issues. But what about the bigger issues that will inevitably arise? Issues such as tenants who aren’t paying and require eviction, unexpected surprises, damage or repairs.

As the landlord, you’re required to be involved in filing insurance claims, responsible for funding maintenance and repairs, and you’re in charge of the general strategic planning and decision-making regarding the overall management of the property.

A Day in the Life of a Passive Investor

As the name suggests, passive real estate investing produces true passive income.

This model of real estate investing allows you to invest your money and let someone else take on the active role of handling the day-to-day operations. 

After investing your money, you won’t have to deal with calls from the property manager or filing insurance claims. The great part about passive investing is that it’s totally passive.

Being a passive investor, however, does mean that you’re required to trust someone with the management, decision making and overall execution of the business. You have to relinquish a little control in order to reap the benefits of a truly passive investment model like that of commercial real estate syndications.

Is Active or Passive Real Estate Investing Right for You?

Here are 10 key factors to help you make your decision.

#1 – Running the Show

If you love the idea of having a hands-on role, having tenants, and making improvements, then becoming an active real estate investor might be a great fit for you.

If you have no desire to deal with the headaches of being a landlord, you should consider the passive route.

#2 – Time Investment

Active real estate investing requires significantly more time throughout the life of the investment. 

Passive real estate investing however only requires your time in the beginning. Once you’ve completed the research phase and made your investment, you can set it and forget it.

#3 – Hands-On Involvement

Determine how hands-on you’d like to be as a real estate investor. Do you want to be directly involved in the management and maintenance of your properties? Or would you rather someone else be responsible for all the heavy lifting?

#4 – Profit Considerations

As an active real estate investor and the only owner of a property, you would get to keep all net profits generated from your investment.

As a passive investor, the net profits are distributed among the investing partners.

This doesn’t necessarily mean that either investment model is better at yielding profits. Each individual investment deal determines the amount of profit you’ll generate.

#5 – Investment Expenses

Active real estate investors are expected to handle insurance claims, emergencies, and repairs. When maintenance and repairs require additional money, the active investor is required to cover those costs.

Passive investors only make an initial capital investment and aren’t required to cover any additional funds unexpected expenses arise. 

#6 – Your Risk and Liability

As an active real estate investor, you are held personally liable if something goes wrong. Meaning you’d be at risk to not only lose your investment property, but also your other assets.

When you’re a passive real estate investor, your liability is limited to the amount of capital you invest. The investment asset is typically held in an LLC or LP. In the event that something goes wrong in the business or with the property, the sponsors are held liable, not the passive investors.

#7 – Admin Paperwork

Active investments require a great deal of paperwork. There’s not just paperwork from the initial purchase, but paperwork throughout the life of the investment.  Types of paperwork required for active real estate investors include tracking purchase and rental agreements, bookkeeping, and various other legal documents.

With passive real estate investments, you typically only need to sign a single PPM (private placement memorandum) to invest in the property. There’s no need to fill out lender paperwork or keep track of any ongoing expenses.

#8 – Type of Team

When investing in real estate as an active investor, not only are you probably a newbie, but you’ll also need to handpick your own team. The team members will include, but aren’t limited to, brokers, property managers, and contractors.

The beauty of investing in real estate as passive investor is that you have the luxury of relying on an experienced sponsor team. The sponsors are the experts in the industry and their shared expertise handles all the moving parts in purchasing and maintaining the investment property.

#9 – Opportunity for Diversification

When actively investing in real estate, you either need to be an expert in the market and asset class or you need to conduct extensive research. Research may include hiring a team and visiting the area yourself.

When you’re passively investing in real estate, you have an opportunity to diversify across different markets. There’s no need to research the market yourself, you’re investing with established teams who have already done the work. These teams have researched the local markets and built strong local teams who know how to best work with and react to changes in the economy.

#10 – Tax Obligation

As an active real estate investor, you’re responsible for your own taxes. You’ll need to work with a CPA to properly depreciate the value of the asset each year, as well as be responsible for the bookkeeping and keeping track of the income and expenses. 

If you choose to be a passive real estate investor, you don’t need to do any bookkeeping. There’s no need to keep track of income and expenses. You’ll simply receive a Schedule K-1 every spring for your taxes. This form shows your income and losses for that property. 

Which Type of Real Estate Investing Is Best For You?

Active real estate investing might be a perfect fit for you if you desire a hands-on role in investing and maintaining your properties personally.

However, if you have no interest in investing time and elbow grease but have capital to invest, you might want to consider becoming a passive investor, using commercial real estate syndications as your choice of investment vehicle.

A middle-of-the-road option, providing more control with less time required could be turnkey rentals and buy-and-holds.

There are many options to consider when investing in real estate. Be sure to determine your unique situation, goals, and interests when deciding which is the right path of real estate investment for you.

And remember, you don’t have to select one or the other type of real estate investment. Plenty of wealthy investors have a few duplexes on the side while they also invest heavily in short-term rentals and multifamily syndications. There is no perfect strategy, only the one you design in support of the lifestyle you’ve been dreaming of.

 

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