WHAT IS PASSIVE INVESTING?
Passive Real Estate Investing: What You Should Know
“90% of all the millionaires became so through owning real estate. – Andrew Carnegie
Introduction
Real estate has proven to be one of the most profitable asset classes—and one of the most resilient. Given dramatic swings in the stock market, it’s no wonder that more people are diversifying and de-risking their portfolios by adding real estate to the mix.
Investing in real estate doesn’t necessarily mean purchasing a $100,000 property and renting it out. It also doesn’t require flipping houses. There are other ways to invest in real estate while still earning double-digit profits.
What’s more, you can reap the benefits of investing in real estate without taking on the responsibility of being a landlord. This is what we call “passive” real estate investing.
Active vs. Passive Real Estate Investing
Before we dive into the benefits of passive real estate investing, it’s worth looking at the difference between active and passive 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 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 is required by active real estate investors often equates to a full-time job.
Passive real estate investing, as its name would imply, is a way of generating passive income through real estate. Passive investors simply bring their capital to the table, and then the active partner oversees the day-to-day and minutia of the deal. Passive investors do not need to identify investment opportunities, renovate properties, lease the space, or deal with lenders and tenants. They can literally sit back and relax while the active investor does this on their behalf.
It can take longer to see the returns from a passive real estate investment, especially compared to an active real estate investor who engages in quick-hit projects like house flips. Depending on the type of deal, passive real estate investors generally earn steady, consistent cash flow distributions and/or a profit when the project is refinanced or sold.
Types of Passive Real Estate Investments
There are three primary ways to passively invest in real estate:
1. Real Estate Investment Trusts (REITS). Investing in a REIT is similar to investing in a mutual fund. Essentially, you are 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 shares at any time, which is a way for investors to preserve liquidity in a way that cannot be done by directly investing in real estate.
2. Real Estate Investment Funds/Syndications. 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. Anyone that has ever purchased an airline ticket has participated in a syndication. You paid for your seat; others paid for theirs. The 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 $75,000 or $100,000 per person. Investors share in the project’s risk and reward, with each being paid out a share of the profits accordingly. 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. Any profit above that threshold will disproportionately 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 capital to the table. Meanwhile, the “general partner,” or GP, takes responsibility for finding and managing deals. 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 aligned.
3. Crowdfunding Platforms. Changes to federal security regulations has made it easier than ever for people to invest in commercial real estate via online crowdfunding platforms. Some platforms require an investor to be accredited, which means they must earn a certain amount and/or have a certain net worth to qualify for that investment. Other platforms offer deals open to the general public, regardless of financial wherewithal. Real estate crowdfunding platforms such as RealtyMogul and Patch of Land, allow people to invest either directly in deals or in a fund that invests in multiple deals. Some allow people to invest in equity, others allow people to invest in debt. The opportunities really run the gamut.
Three Reasons to Passively Invest in Multifamily Real Estate
As we noted above, passively investing in multifamily real estate can be highly profitable. Those who pursue this approach will realize there are three key benefits to passive investing:
Ability to Harness an Expert’s Expertise and Experience. Many first-time real estate investors do not have the time or experience to devote to active real estate investing. This makes passive investing attractive. Passive real estate investing allows you to harness the expert’s deep understanding of the industry. Ideally, the person you invest with will have several years’ experience particularly in the asset class and market you’re considering.
No Need to Deal with Tenants, Trash, and Toilets. Landlords often find themselves addressing their tenants’ issues on weekends and at all hours of the night. They spend their valuable time managing properties, dealing with tenants, and so much more. The same is true for house flippers—they spend so much time at the property that they’re left with little free time to themselves. One benefit to passive investing is that these responsibilities fall to someone else.
Ability to Invest in Numerous Properties in Different Markets. Investing in a property directly means that an investor is taking on a lot of risk with their hard-earned capital. An alternative is to passively invest smaller amounts across multiple projects in different markets. This is the best way to diversify and de-risk your investment portfolio. For example, if the office market takes a hit, your investment in multifamily will bolster the underperforming asset.
Conclusion
There’s nothing wrong with active real estate investing—it just requires a lot of time, effort and capital. It’s not for everyone. Those who would prefer to spend their time with friends, family or pursuing other ventures will find passive investing a better path.
“The moment you make passive income and portfolio income a part of your life, your life will change.” - Robert Kiyosaki
Ready to passively invest in multifamily real estate? Contact us today to learn more.