Passive real estate investment income characteristically comes from income streams that are fairly automated. The investment you make, whether it is in stocks, mutual funds or the real estate market, entitles you to an ownership stake that pays distributions, dividends or other classifications of income on a regular basis. Further, you usually do not have any management responsibility for that investment, as that role is taken on by others.
In the context of this thought leadership platform, passive real estate investing is a way to invest in real estate where you place your investment funds into a real estate project in which you will not have any direct management responsibility.
The advantages of participating in this type of investment:
- You can still continue to earn a living at your high-paying job without having to spend time or effort with the day-to-day management of the property.
- As you accumulate wealth, whether at your job or otherwise, passive investing allows you to preserve that wealth.
- Some people like the idea of creating a legacy that can be passed down to heirs.
- Many real estate investors like to find ways to generate residual income. (Some call this Mailbox Money.)
Difference Between Active and Passive Real Estate Investing
One of the main differences between passive and active real estate investing is the amount of continuing effort involved to sustain the health of the investment.
Active: Usually means owning the investment directly, without any intermediary company or mechanism to distance yourself from that investment. Think about your home. Chances are that you might own this in your own name. You control any upkeep and maintenance, pay taxes, and keep current with mortgage payments, and are therefor an active investor.
Passive: In most cases, you are providing the funds for a syndication or partnership, and other people are running your property. They are the stewards of your investment and do their best in providing the fiduciary responsibility necessary.
Being actively involved with multifamily real estate requires extensive knowledge and can be a hassle for the property owner/manager. Passive real estate investing doesn’t always require this vast experience and can offer diversification, a certain amount of safety, and the ability to keep capital working. Investors can invest through syndications, partnerships, crowdfunding online, individual real estate blind funds, and real estate investment trusts (REITs).
This implies taking title to a rental property yourself and not through a third party. The IRS classifies an investment in multifamily real estate, whether gaining title to the property directly in your name or through another entity, as a passive investment. It defines passive investment income as gross receipts derived from royalties, rents, dividends, interest, annuities, and sales or exchanges of stock or securities.
As a direct passive investor, you would acquire a property or portion of a property (in your own name or entity) that is then rented out. You might then hire a property management company to manage the day-to-day activities and tasks such as rent collection. This is essentially a hands-off way to manage the property, and is why this is considered passive.
But this isn’t as passive as it can get…
IRS doesn’t differentiate how title is held, in the case of real property, but in my mind, I do. It is my opinion that true passive income is through an investment that you do not control directly – an indirect passive investment.
An indirect passive real estate investment is where you might invest in a REIT or syndication. You are buying shares of a third-party company who is buying a property. (There might not even be one specific property.) You are not buying the property directly. This form of real estate investment is considered truly passive because there’s no day-to-day management required on your part, and you collect passive income as returns, dividends or distributions.
A real estate investment trusts (REIT) can be a corporation, trust, or association that invests in income-producing real estate. One advantage here is that you can invest in real estate without the expense, knowledge and management responsibility needed on buying actual property. Many people like REITs because of the ability to diversify risks and still take advantage of appreciation and income. They are traded like stocks and investment minimums can be really low, like less than $500 per share. Though by SEC rules the REIT must distribute 90% if its income to shareholders, you do not usually get to take advantage of depreciation.
There are many types of REITs. One is an equity REIT where it buys, owns, and manages real estate properties that generate revenue. It is the revenue from rents that investors find appealing. Another type is a mortgage REIT which makes its money from interest payments by loaning funds for mortgages to real estate owners and operators, or even investing in existing mortgages or mortgage-backed securities. A hybrid REIT is the combination of the two. There are publicly-traded REITs, public non-traded REITs, and private REITs.
This has become very popular in recent years, and has democratized passive real estate investing by expanding access to multi-million-dollar ventures. It is basically a method for raising funds and is commonly used by syndicators, and is typically managed or operated through an online platform, enabling you to own property and earn profits with minimal effort. You can browse through the opportunities on a marketplace website and choose an investment that matches your needs. The platform also gives you the ability to track the performance of your investment and see the passive income it generates.
Many other investors will be doing the same, allowing for the syndicator to pool the funds necessary for a project to begin. Some syndicators who might have a very lucrative deal just do not themselves have a huge number of investors to offer to, so crowdfunding exposes them to many investors that they may not have had access to previously.
I consider this type of real estate investing more active than passive. On its surface, this can be a good way to create potentially steady cash flow without much effort. This is where you buy an investment property with the intention of contracting the management of the property to the company selling the property to you. There are many groups out there who put these types of deals together, often exacting a premium on the final acquisition price.
The idea is that you will not have to lift a finger toward the property even though you are the direct (active) owner. You are trusting the management to make the property profitable without having any direct influence on any outcomes. While this seems like an ideal arrangement, this is one of those things that can be too good to be true. I have seen many, many examples of property owners trying to sell their property because this arrangement just didn’t work out as planned, and was costing them dearly.
I feel that the most passive way to invest in real estate is through a syndication, though quite a bit of effort can be expended in finding a suitable project or sponsor (organizer). Thus, the name, Actively Passive. It takes a lot of energy to be ‘lazy,’ but it is worth it. A syndication is the pooling of funds from many investors to participate in a single real estate opportunity or project.
Through syndicating, an otherwise cost-prohibitive investment becomes more accessible for the individuals. Usually, a syndication is all about a single property, though some syndications can be organized to take part in multiple properties (through a blind fund for example). When you invest in a syndication, the general partner (sponsor) will manage the property, and you (the investor) are the limited partner, having no management responsibilities or expectations.
A syndication investment is usually for a defined term, like for 3-7 years. In its business plan, the syndicator will define what it is going to do with your money and how you will be participating in the profits it generates.
The less time you need to spend on your real estate investment means that you have more time to devote to the things that really matter in your life: loved ones, hobbies, your 9-5 job, or even lounging around on your couch like I like to do. Your job in growing or preserving your wealth is to manage the managers. I think the best way to do this is through investing in syndications, as it gives you the opportunity as well as flexibility to be in real estate but not have to manage the day-to-day activities involved.