Should You Be An Active Or A Passive Real Estate Investor?

by | Jul 14, 2022 | Investing Advice

Most real estate investors get their start by buying a small rental property or two and serving as the landlord. Often, investors mistakenly think that’s the only way to invest in real estate. 

In the beginning, we took on our fair share of fix-and-flips and became a landlord for multiple small rental properties. Although it sounds good in theory, the more properties we had, the more time was required, and the more stress it brought.

Luckily, we discovered that we could invest in real estate passively. That means you never have to deal with the headaches of tenants, toilets, and termites. While it may sound too good to be true, it’s possible to get all the benefits of investing in real estate without any of the hassles of being a landlord.

In this article, we’re breaking down what it means to be a passive real estate investor. Hopefully, you’ll gain a little clarity as to whether you should be an active or passive investor.

 

The Life Of An Active Real Estate Investor

If you’re like most people, the words “Real Estate Investing” bring residential rental property ownership to mind. Rental property investors buy a single-family home, find a tenant, and collect monthly rental income. Sounds easy enough, right? Unfortunately, the reality is usually quite different.

When you’re the landlord of rental properties, you have an active role in the investment. Even if you hire a professional property management team, your active participation is required.

While the property managers may take care of the day-to-day operations, you’ll still need to be involved in making strategic decisions, including things like evicting tenants who aren’t paying and filing insurance claims. Unexpected surprises are also your responsibility. When unforeseen issues arise with a property, that usually means potentially putting in additional funds to cover maintenance and repair costs.

 

The Life Of A Passive Real Estate Investor

As a passive investor, on the other hand, you simply invest your money and let someone else do all the heavy lifting. 

Passive real estate investing is entirely passive. You never have to worry about getting calls from the property manager, you’re not responsible for screening tenants, and you don’t have to file any insurance paperwork.

As a passive investor, you’ll have to relinquish some of your control over the investment. You have to trust the sponsor team (Russell and Julie) to manage the property and execute the business plan on your behalf by giving up your active role in the investment.

 

Is Active or Passive Real Estate Investing the Best Fit for You?

Here are ten factors to help you determine if you should become an active or a passive real estate investor.

 

#1 – Landlord Hassles

If you love getting your hands dirty and thrive off of troubleshooting unexpected issues, being a landlord, or an active investor, might be a perfect fit for you. 

 

On the flip side, if the thought of having tenants and making constant improvements to a property makes you nauseous, you should go the passive route.

 

#2 – Time Commitment

There’s no way around it; active real estate investments require more time. The time commitment is required during the initial acquisition of the property and continues throughout the project’s lifecycle. 

Passive investments only require your time upfront during the research phase. Then, during the remainder of the project, you can sit back, relax and collect your returns.

 

#3 – Level of Involvement

Some people are just made to be landlords. If you like managing the property yourself, fielding tenant requests, and scheduling maintenance and repair appointments, an active role might be just what you need. 

If you’d rather focus on what you are best at, or have more time w your family while someone else does all of that, a passive investor role might be an excellent fit for you.

 

#4 – Profit Distribution

With active real estate investing, you’ll likely be the only owner of the property, meaning you get to keep any net profits. With passive investing, the profits are distributed among many investors. 

Keep in mind that this doesn’t necessarily mean that one type of investment will net you higher returns than the other. As with every deal, you’ll need to complete your own due diligence and compare the financial details.

 

#5 – Unexpected Expenses

Active real estate investors are responsible for handling insurance claims, emergencies, and property repairs, which, as you know, will likely require additional time and money. 

Passive investors are only required to make an initial capital investment.

 

#6 – Risk and Liability

There’s more risk involved with active investing. If things take a terrible turn, you’re held personally liable. This puts you at risk to not only lose not just the property, but also your other assets. 

With passive investing, your liability is limited to the capital you invest. The asset is usually held in an LLC or LP. In the event that something goes terribly wrong, the sponsors are held liable, not the passive investors.

 

#7 – Amount of Paperwork

Active investments are paperwork intensive. As a result, you’ll be completing paperwork throughout the project’s life. This includes paperwork from the initial purchase of the property to tracking purchase and rental agreements, bookkeeping, tax documents and legal documents.

With passive real estate investments, you would likely sign only a single PPM (Private Placement Memorandum) to invest in the property. As a result, there’s no need to fill out lender paperwork, file for insurance, or bookkeeping.

 

#8 – Building a Team

As an active real estate investor, you must build your own team, including brokers, property managers, maintenance contracts and contractors like plumbers and HVAC personnel.

However, as a passive investor, you get to rely on the shared expertise of the sponsor team. The sponsors are experts in the market and typically already have a team to manage the property.

 

#9 – Opportunity for Diversification

Active real estate investing requires you to be an expert in the market and area, as well as the asset class you’re investing in. In addition, investing outside your local area can be time-consuming because you must research the market, travel back and forth from that market, find a boots-on-the-ground team, and oversee the project from afar.

With passive investing, it’s much easier to diversify across different markets. This is because you’re investing with teams that have already taken the time to research those markets and build strong local teams, meaning you don’t have to start from scratch with each market.

 

#10 – Managing Taxes

As an active investor, you’re responsible for bookkeeping and keeping track of the income and expenses. In addition, you’ll need to work closely with your CPA to make sure that you are correctly depreciating the asset’s value each year.

As a passive real estate investor, you’re not required to do any bookkeeping. Instead, you’ll simply receive a Schedule K-1 every spring for your taxes, which shows the income and losses for that property. So there’s no need to track income and expenses throughout the year. 

 

How To Determine If Active Or Passive Investing Is Right For You

If you’re ready to roll up your sleeves and take on everything being a landlord has to offer, active investing just might be just the adventure for you. 

If you have the capital to invest but your time is limited, you might consider passively investing in real estate. 

There are also middle ground options available, like turnkey rentals and buy-and-holds. These investments may provide some control without requiring so much of your time.

To determine which type of investing is right for you, make sure to consider your unique situation, lifestyle, personal goals, and risk tolerance.

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