I’m not gonna lie. When I first started investing in real estate, I thought the easiest way to “ease in” was to buy a small rental property and try my hand at management. It seemed simple enough, and I thought I’d make a darn good landlord for some lucky tenants!
So, I rolled up my sleeves and started to invest in one rental property after another in my search for financial independence. Instead, I quickly noticed that more properties meant more of a time commitment.
I was not turning out to be the rockstar landlord I thought I’d be (although I am still a rockstar in other ways) and started to lean away from rental management. What I really wanted was passive income and time freedom.
I went back to the drawing board, and by that I mean I looked at what had made my family successful for generations – multifamily properties. That was the key to real estate success without having to deal with tenants, toilets, or termites.
Ready to learn about this exciting opportunity? Walk with me through this article to find out what it means to be a passive real estate investor and to discover whether active or passive investing is for you.
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, AirBNB collect monthly rental income.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, but you will still need to be involved in strategic decisions, including whether to evict tenants who aren’t paying, filing insurance claims when unexpected 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, you have passive investing, which are the “set it and forget it” type of real estate investments. 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 trust someone else (i.e., the sponsor team) to manage the property and execute on the business plan on your behalf.
Should You Be an Active or Passive Real Estate Investor?
Here are 10 factors to help you decide which path is right for you.
#1 – Tenants, Termites, Toilets, and Calls at 3 AM
If you’ve dreamt of becoming a landlord, having tenants, and making improvements, then 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 not just the property but also your other assets.
With passive investing, your liability is limited to the capital you invest. Typically, the asset is held in an LLC or LP. If anything goes terribly wrong, the sponsors are held 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.
With passive real estate investments, on the other hand, 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 own 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 would need to be an expert in the market and asset class you’re investing in. If you’re investing outside your local area, you would 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 properly depreciating the value of the asset 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. Right now, with current bonus depreciation laws in effect til the end of 2022, you can reap great benefits through losses on your income taxes.
So, Are You Cut Out For Landlording Or MF Investing?
Now, if you read this entire article thinking, “I am ready to get in there, roll up my sleeves, deal with tenants at 3 am, and fix that disgusting toilet!” Then you are made to be a landlord! ! If this is the case, active investing is right where you want to be.
However, if everything I’ve shared has you thinking about how limited your time is, that you have the money to invest but would rather not manage property or people, or that you want big benefits like accelerated depreciation and you don’t think you can get that from one or two residential rentals, then passive investing is for you.
If you want to be right in the middle, turnkey rentals and buy-and-holds may provide some control without the huge time commitment.
When it’s all said and done, you are the only one who can determine your best path. Factor in your situation, goals, and interests to determine whether passively investing in multifamily real estate alongside me is your next move.