When I met Warren, he owned a few single-family homes across the country as rental properties with the plan that when he retired from the Navy, he’d sell them to fund his retirement property fully. I saw the potential in his dream too, but we both began to see flaws as well.
A military career affords a great deal of security but offers little wealth. We thought single-family rentals would be a great way to balance the equation.
We quickly noticed that the margins were slim, property management fees were steep, and tenant occupancy rates had the power to make or break us for the year.
That’s when we discovered that you could invest in real estate without the headaches of tenants, toilets, and termites. It’s true – you can get all the benefits of investing in real estate without any of the hassles of being a landlord.
In this article, you’ll see what passive real estate investing means and find out 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. This is how we began. The process sounds easy enough, but the reality can be quite different.
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, we discovered passive investing in 2014, 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 that you relinquish some of your control in the investment and must 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?
Would you enjoy being a landlord – fixing up properties yourself, making day-to-day decisions about renters, and necessary maintenance? Or are you willing to give up some control and just collect the checks?
Here are ten factors to help you decide which path is right for you.
#1 – Tenants, Termites, Toilets, and Calls at 3 AM
If you dreamed 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 owner of the property, so you would get to keep any net profits. With passive investing, the profits are distributed among many investors.
This 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, whereas passive investors only make an initial capital investment.
#6 – Risk and Liability
With active investing, if things go south, you are personally held liable, which means you may lose the property and your other assets.
With passive investing, your liability is limited to the capital you invest. Typically, an LLC or LP will hold the asset. If anything goes wrong, the sponsors are 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.
On the other hand, with passive real estate investments, 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 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 in which you are investing. 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 that you will need to keep track of the income and expenses. You’ll also need to work with your CPA to make sure that you are correctly depreciating 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.
Is Active Or Passive Real Estate Investing Right For You?
If you’re ready to roll up your sleeves and get involved in the various aspects of being a landlord, active investing just might be the perfect adventure for you.
However, if your time is limited (maybe you’re working full time or have a busy family life?), but you have the capital to invest, you might want to consider being a passive investor.
If you’re hoping for a middle ground option, turnkey rentals and buy-and-holds may provide some control without the considerable time investment.
We’ve experienced both and are happy to share more about our experience if it helps you. We still own one of our most low-maintenance rental properties to this day, although we are much more heavily involved in real estate syndications. We wanted the ability to invest in tangible assets, design a lifestyle we love, and enjoy the benefits of owning real estate while experiencing the freedom of retirement and working when we want.
When determining the right path for you, be sure to factor in your unique situation, goals, and interests. We’re all at different stages in life, have had different experiences, and have various objectives. Wherever you are, we invite you to join the Starboard Equity Club, where you may share your goals with us so we may help steer you toward your best investment fit.