04/06/2022
ACTIVE INVESTING, PASSIVE INVESTING, OR BOTH?
Real estate investing has many benefits: Monthly cash flow, appreciation, tax benefits and more.
Sometimes, people are told to buy rental property, then just sit back and collect passive income.
An investor who follows that advice might buy a rental property, only to realize it’s a lot more work than they had expected!
This is one reason it's important to understand the difference between active and passive real estate investing – a distinction that many people overlook when investing in their first rental properties.
ACTIVE REAL ESTATE INVESTING
Active real estate investing is when a person, entity or fund is directly involved in the investment process. In short, active real estate investing requires YOUR time, YOUR capital, and/or YOUR risk.
An active investor is fully engaged in the process, either entirely from beginning to end, or heavily in parts of the process (such as acquisition or renovation). The level of commitment that’s required by active real estate investors often equates to a full-time job.
Wholesaling, flipping, being a landlord, raising capital, and being a general partner are some examples of being an active investor.
PASSIVE REAL ESTATE INVESTING
Passive real estate investing, as its name would imply, is a way of generating passive income through real estate.
Just as there are multiple ways to be an active investor, there are many ways to be a passive investor.
You can invest in a real estate investment trust (REIT), which is like a mutual fund. Essentially, you’re buying stock in a real estate portfolio that is actively managed by the REIT. According to federal regulations, REITs are required to return 90% of profits to their investors. The benefit of buying into a REIT is that you can buy and sell its shares at any time. The asset class is more liquid than traditional real estate.
Another approach is to buy into a real estate investment fund, a process often referred to as syndication. Don’t let the fancy name throw you off – most people have participated in a syndication at one point or another. If you’ve ever purchased an airline ticket, you’ve participated in a syndication. You paid for your seat, as do others. In total, revenue generated by each ticket sale is used to pay the airline, pilot, government fees, etc.
Real estate syndication is similar.
You invest in a real estate deal alongside several others. Each project may have a different minimum requirement, say $250 or $10,000 per person. Investors share in the project’s risk and reward, with each being paid out a share of the profits accordingly. Usually the project sponsor will take a small administrative fee, but that sponsor usually falls at the bottom of the equity waterfall, meaning they are repaid last, only after investors have been repaid their equity stake at the agreed upon terms. A split of any profit above that threshold will go to the project sponsor.
One of the benefits of real estate syndication is that you, as an individual investor, are considered a “limited partner.” The only responsibility of an LP is to bring the capital. Meanwhile, the “general partner,” or GP, takes responsibility for finding and managing deals. Typically, the GP brings their real estate expertise in exchange for a share of the profits but is paid out only after the LPs have made their profits. This structure ensures that the GP/LP’s interests are always aligned.
Similarly, a real estate fund will pool investors’ resources and then can deploy that capital across an array of real estate projects depending on the goals of the fund.
After you invest in a REIT, real estate fund or syndicated deal, there’s not much more you need to do. Sit back, relax, and collect income accordingly.
If this is what you have in mind when thinking about investing in real estate, one good way to find out more is to connect with other credible investors, investment groups, and masterminds.
