You want to invest in real estate but you’re hesitating. You’ve listened to a hundred podcasts, read “Rich Dad, Poor Dad” three times and have been lurking on BiggerPockets for months. “How do I get started in real estate?” is stuck on repeat in your brain.
An old buddy from med school is pushing you to buy an apartment building and talk about how much he made on his last flip. Your in-laws roll their eyes when you mention an apartment complex and warn you about the drama of tenants and overflowing toilets, telling you to leave it to the professionals. Then they ask you why you even want to invest in real estate and when will there be another grandchild?
Seriously though – you’ve researched real estate as an asset class and understand how real estate investing can benefit your investment portfolio. Once you’ve committed to adding real estate to your holdings (disregarding your well-intentioned inlaw), how do you choose between DIY real estate investing and turning your money over to a pro? Which real estate investing strategy is better for you – active or passive real estate investing?
The truth is you can make money with either strategy – but which one is the best path to building wealth for you as an individual? Yes, your med school buddy is making a killing hustling for deals, but is getting your hands dirty what you really want? Take our 5 question test and learn your ideal real estate investment strategy!
But first, a quick review of the two types of real estate investing strategies: active real estate investing versus passive real estate investing.
What is an active investing strategy? Active real estate investing is a real estate investment strategy in which you, the investor, personally buy a piece of real estate, whether it’s for a vacation rental, flipping, or buy and hold investing. It could be anything from a single-family home to a multi-family residential, but whichever you choose, you are responsible for every aspect of the deal. You find the building you want to purchase, secure financing, personally guarantee the loan, and then manage your investment on an ongoing basis. It will be your job to screen potential tenants, set rents, and schedule maintenance. If you are renovating and selling your property, you need to hire and manage contractors or do the work yourself, stay on top of renovation plans, make all the financial decisions, then hire a realtor to sell or FSBO it yourself. If you don’t know something, you had better learn it fast as you are the captain of the ship. As you can see, active investing is as much of a time investment as it is a financial investment. However, if it goes well, you earn the lion’s share of the returns and can rapidly create value and grow your real estate portfolio.
Passive Real Estate Investing
Passive real estate investing is a hands-off investing strategy that earns cash flow without the same time commitment or mental energy. What is considered a passive real estate investment? Passive real estate investing commonly includes syndications, REITs, and real estate ETFs. As the investor, you place your capital into an investment, like a real estate syndication, that is completely managed by a sponsor. You will essentially be outsourcing the deal sourcing, financing, and management to someone who knows their stuff. That professional investor will pool funds from a group of investors to fund the purchase of a large real estate deal and then follow a business plan (agreed on prior to investing) and run day-to-day operations, all while keeping investors in the loop monthly or quarterly. You simply put in your capital and receive your part of the passive income.
The Difference Between Active and Passive Investing: An Example
To illustrate the difference between active and passive real estate investments, let’s look at an actual example: a multi-family residential property (aka an apartment building). As an active investor, if you wanted to purchase an apartment building as an investment property, you would be responsible for sourcing and financing the deal, getting a loan, screening prospective tenants, collecting rent, attending to tenant needs, hiring contractors for maintenance, on top of the bookkeeping and tax filings. You would receive monthly cash flow from the units that were rented, and a potential return on the sale of the apartment. On the other hand, if you were you to invest your money passively, as in a multi-family syndication, the sponsor would be responsible for all of decision making and management. You would do your due diligence upfront to vet the sponsor and the deal, then your involvement ceases. After you make the initial investment, you receiving a portion of the cash flow as passive income, and a potential payout at the time of sale from the capital gain when the syndication ends.
Remember – you can make money with either an active or passive real estate investing strategy (some people even do both!). But investing wisely isn’t just about dollars – it’s also choosing the best investment strategy for your lifestyle. Your honest answers to the following five questions will guide you to a successful start in real estate.
Question 1: Are You a Control Freak?
Some people cannot function unless they control every decision in their lives. Others have a more laissez-faire attitude. Most of us lie fall somewhere on the spectrum between total control freak and investing slug.
As an active investor, you have control on every level, whether you want it or not. You decide what to buy, whom to rent to, what renovations to complete, and how much to charge for rent. Everything comes to you and through you for the lifetime of your investment.
When you are participating in passive real estate investing, as in a syndication, you are a limited partner in the deal. This means your control is limited along with your involvement. You are passing your control to an experienced syndicator who will pool your money, along with that of other investors, to purchase and manage your real estate investment.
Give yourself 1 point if you are a control freak.
Question 2: Do You Have Free Time?
We all have the same 24 hours in a day. With active real estate investing, having more control comes with the trade-off of a greater time commitment. You are the landlord, with all the responsibilities that come along with that title. It will be your responsibility to plan and oversee any renovations if those are required before, during, or after you rent to tenants. All of this happens on an ongoing basis, on top of the time it will take you to find a deal and secure financing. Sure, you can hire a property manager to handle the rent collection, maintenance requests and tenant screenings, but you still have to find, vet and manage the property manager. Anyone who tells you that owning property with a property manager is “passive” investing is flat out wrong. Even with a property manager, you still have to dedicate significant time to your real estate investments. Active investors also need to continuously be in pursuit of information about the markets where they invest. You will need to constantly look at properties in your market to know a good deal when you see one so you can snap it up before someone else.
Passive real estate investing requires minimal to no time commitment. Once you have vetted your passive investment thoroughly prior to investing, you hand over your money and receive updates monthly or quarterly on the investment’s progress.. You don’t need to worry about any landlord duties or obligations and no one will ever ask you permission to buy a new toilet. While you do need to keep abreast of the markets you invest in, you don’t have to scour the business journal for every market blip as the professionals managing your money will do that for you.
Add 1 point if you have time (or will make time) for real estate investing.
Question 3: Do You Like Other Humans?
Good deals do not fall from the sky and hit you on the head. Real estate is a people business – that bears repeating – real estate is a people business. It is not a numbers game, contrary to popular belief. It takes a great deal of experience, local knowledge and networking to develop a high-quality deal flow. And that means cultivating relationships with people who are smarter, more experienced and better connected than you. while simultaneously schmoozing other investors, realtors, wholesalers and brokers to get those great deals in the first place. So consider, do you like other people? Because you will have to talk to a lot to them to build a real estate portfolio.
As a passive investor, you outsource the whole process of obtaining the investment to an experienced syndicator who can find quality investment opportunities with their pre-existing network. A good syndicator or investment manager will have a network of deal sourcing professionals – other investors, property managers, brokers and wholesalers that hunt for deals all year long. They make friends so you don’t have to.
1 point for being an extrovert or an introvert willing to speak to other people.
Question 4: Are You Comfortable With Risk?
Everyone has a different personal threshold for risk. What is comfortable, even enjoyable, for one person can trigger a full-blown anxiety attack in someone else. Some people will argue this point but active real estate investing is a riskier strategy than passive investing. Purchasing properties yourself exposures you to financial risks – you guarantee the loan and you are solely responsible for unexpected expenses. It is your financial neck on the chopping block. Not to mention that you are solely responsible for executing – there’s no one else to take over or blame when things go badly. There is management risk with active investing and that risk is that YOU are a bad manager. With the higher risk though, comes a higher potential reward. You own all of the deal and get all of the profits.
Passive investment lower your risks, both management risk and financial risk. You invest your capital with someone’s experiences which should lower your management risk. You are also only on the hook for the amount invested and don’t guarantee a loan personally. (Some investors would argue that owning the asset yourself as an active investors give you collateral and therefore more security, but I think the management and financial risks outweigh the benefits of collateral for most real estate investors)
Add 1 point for being a risk-taker.
Question 5: Do You Love Real Estate?
The single most important question! On your days off, do you check out open houses just for fun? Is realtor.com like catnip to you? When you drive by apartment buildings on your way to work, do you try to figure out in your head how much is the cash flow? If so, you’re a real estate junkie. If not, you probably don’t love real estate. It’s tough to be good at what you do if you don’t love it. If real estate is drudgery to you, it’s going to be a challenge to be successful as an active real estate investor. Of course, you can still commit yourself to the education process even without a passion for active real estate investing, but it’s a lot less fun.
Give yourself 3 points for being a real estate addict
Subtract 3 points if you don’t love real estate
Test Time! Active or Passive Real Estate Investment, Which Strategy is Right for You?
7 Points = You’re an active real estate investor!
5-6 Points = You might be ready to DIY your real estate empire. But know your limits and educate yourself first
3-4 Points = Magic 8 ball says “Ask Again Later”. Leave it to the pros for now.
1-2 Point = Don’t buy a building just yet. Stick to passive investing.
0 Points = Passive all the way! (And I’m surprised you read this far)
In the end, investing in real estate, whether actively or passively, can put you on the path to financial freedom. Both active and passive investment strategies can generate income and build long-term wealth. Choosing one strategy now does not commit you to that path for life if your circumstances or passions change. Picking the right investing style for where you are now will let you grow your wealth without surrendering your piece of mind. As time goes by, your strategy will and should change as you change.
If you’re curious, I practice both strategies – active and passive real estate investing. My score is a 7 and I genuinely love real estate investing – but I passively invest in markets and asset classes where I lack the expertise to go it alone.
Have questions? I’ve got answers. Feel free to email me if you want to learn more about your personal real estate investment strategy.