When it comes to whether you want to invest in real estate, you need to determine if you are wanting to be an ACTIVE or PASSIVE investor. There are pros and cons to both strategies, lets take a dive into the differences and see which is best for you.
ACTIVE REAL ESTATE INVESTING
Active investing: The investor personally purchases a property to either fix and sell for a profit, also known as flipping, or for rental cash-flow. It can be any type of real estate from commercial space to a single-family home or a large multifamily property. This type of active investing involves the investor to be involved in every aspect of the deal from searching, financing, management and closing of the asset.
PROFIT: Active investors usually will see a larger share of the profit, because this type of investor is doing most of the leg work, not relying on as many 3rd party partners on the deal. It doesn’t mean they will be more profitable just means they don’t need to spilt as much of the profit.
CONTROL: Investor is handling every detail of the investment, from rental rates, tenants, improvements to the property and depending on your style, doing a lot of the remodel work themselves to increase margins. You are in the driver seat.
LEVERAGE: Investor is usually the only source of capital, whether that is by cash or financing, which usually will limit how many investment properties they are able to purchase.
RISK: Usually when someone is keeping all the profits, they are also assuming all the risk with the asset. If something happens or unforeseen cost is accumulated, the active investor absorbs all the losses from it, mainly because due to the inability to leverage as much, they are unable to spread and diversify the risk across multiple investments.
TIME: A lot of active investors do not factor in time required. Real estate isn’t a set it and forget it type of investment, it requires the investor to be involved in all aspects, from acquisition, due diligence, financing, legal compliance, maintenance and tenants. Some of this can be outsourced through a property management company, however the active investor is still the main and final decision maker for the asset.
PASSIVE REAL ESTATE INVESTING
Passive investing: Investor who would rather have a hands-off approach and place their capital into a real estate syndication, usually a large apartment complex, that is managed entirely by a sponsor. This type of investing allows investors to outsource almost every aspect of real estate investing, from sourcing properties and management to the sponsor. Sponsors are able to pool funds from many investors and partners to buy larger properties, in which they then execute specific business plans, run everyday management of the asset and report back to investors.
CONTROL: Asset’s managed by a sponsor do not allow individual investors to maintain many voting rights, mainly because if passive investors retained control on the asset, you would be allowing the asset to be controlled by other passive investors who are likely NOT experts when it comes to management of the particular asset. Doing due diligence on the sponsor/operator of the asset is crucial.
PROFIT SHARING: Profits are shared amongst a larger group of individuals, the sponsor/operator and other investors. This doesn’t mean there will be any less profit on the asset, only that they are shared.
TIME: Passive investment means the only real work you need to do is choose a sponsor/operator or syndicator to partner with. You do not need to worry about the nitty gritty of occupancy, tenants, maintenance and repairs. Syndication means all that is taken care of and usually at less cost than doing it yourself, due to the size of the property and ability of sponsor/operator to negotiate discounted deals over multiple properties.
RISK: Due to the nature of syndication the passive investor does not incur any risk in regards to liability or credit. This in my opinion is a major add in value, because it grants you access to low-cost financing through the operators/sponsors track record without any of the associated risk to it. You also will have experts in the field of multifamily executing the business plan and handling the problems that will unquestionably arise managing large multifamily assets.
EXPERIENCE: In single-family real estate investing, there is not a big difference in the management of one asset versus another, they are relatively the same, where an operator isn’t quite as valuable. However, there is a big difference in managing a 4-plex vs a 100+ unit multi-family apartment, which is very much like an operating business, an operator here can provide invaluable relationships, systems, processes, know-how, justifying the need for their participation for the asset, that the passive investor can rely on.
RETURNS: Because of the reasons listed above, your return as a passive investor might actually be similar to what an active investor may achieve on their own, this passive approach does not require the investors time once the investment is made. This, in my opinion, is the biggest advantage to passive investing.
WHAT IS BEST FOR YOU
Everyone is different, I know plenty of active investors and they love it. The only person who can decide is you, I know people who do a little of both, I’m one of them.
When choosing an investment strategy, I always take into account my ultimate goal. If you do not have one, make one. I like to actively invest in where I know that I am competent in my abilities and expertise. Investments I know I’m not, that is where I am more passive and looking for the expert.