Passive vs. Active Investing

12 Reasons Why You Should Be Investing Passively

When most people learn about making money in real estate it is usually a family member or friend that has bought a few rental properties or maybe even some apartments, maybe they’ve flipped a house or two. These are active investors, they have to hire a team or manage all operations themselves. Passive investing is taking part in the return on deals, without the responsibility of work or management. Because of my background in construction, I do both, but for most people passive investing is the best way to become truly financially free. Here are 12 reasons why you should consider passive investments:

1. Leveraging other people’s time, work, knowledge, expertise, networks, competitive advantages, and credit. How long did it take you to become an expert in your profession? Years of school, internships, networking events, and working your way up the ladder. What if you just found a company that has put in the work and has created the framework to be considered one of the best at what they do? You can let their team find the best deals and manage the assets at the highest level for you.

2. You can continue with the job you are trained to do and are already an expert in. Starting over in a new field, an active Real Estate investor, is just like starting in any field; you are going to start at the bottom. You will have trouble finding good deals and it will take a while to build up a good team to properly manage the asset. You can stay in your job where you already have a steady income and continue to add to your savings with new passive investments.

3. Similar Returns. Because of the competitive advantages that these large operators you are investing with have, you will most likely see the same returns as buying your own property. Their connections get them deals that you would never have access to and their huge properties attract the best management teams. Typical small active investor deals are run like a side hustle where as large operators with whom you can invest your passive income with, are run as a large professional corporation.

4. Incentive alignment. In a good passive investment deal, the operators incentives will be highly aligned with that of the investor. There is usually a preferred return (pref) for investors followed by an equity split. This means that the investors get paid the pref before the operator gets to share in the proceeds. You can bet that operators will do everything in their power to make the investors great returns because that is the only way the operators will make money.

5. Predictable cash flow. Many passive investments come with a pref rate and a predicted yearly cash flow. When the asset performs as predicted, the investors will receive checks on a regular basis (usually monthly or quarterly) for their share of the profits. Many times, active investors will have unpredictable or no cashflow during the time that they hold the asset. If 10 tenants leave a 100 unit apartment complex you still have 90% occupancy, if 1 person leaves your single family rental you have 0% occupancy.

6. Freedom. You can be a passive investor from anywhere in the world, no matter if you are working 80 hours weeks or completely retired. Once you do your due diligence (usually online) and committed money to an investment, there are rarely ever times that you will need to be contacted. You can continue on with whatever amazing life you’ve dreamt of and let the checks hit your bank account. Active investors, even with a good property management company, are constantly on the hook for decision making, emergencies, vacancies etc.

7. Diversification. Active investors are usually very niche. One asset class, one city. As a passive investor you can diversify your portfolio across multiple asset classes, operators, and locations. 2012 was a great year to buy A-class apartment buildings in Los Angeles, and as those opportunities dried up, opportunities arose for self storage facilities in the south, and now with the baby boomer generation getting deeper into retirement, there is a huge opportunity in senior housing in cities with an older demographic. There is no way as an active investor you could create a team that could handle changing asset classes as fast as the opportunities come and go.

8. Reduced legal risk. When you invest passively you are considered a limited partner. Your name is not on the loan and you hold no responsibility for the management of the asset. The active investor, or general partner/operator, is the one signing on the loan and putting their reputation and livelihood on the line with every decision. Even with “nonrecourse” loans there are ways that the general partner can be liable for the debts.

9. Same tax advantages. When investing in syndications, you are part owner of the property so therefore get to share in the tax benefits. Just like owning a single family rental, you can write off depreciation of the asset to counteract the cash flow you have received. Make sure you are investing in equity and not debt; if you give someone a loan you are not an owner of the property.

10. You can use your retirement accounts. You can set up self directed IRAs and 401ks that allow you to passively invest in real estate. This is typically not an option for active investors because you are not allowed to invest in a company that compensates your or any of your family.

11. Low barriers to entry. You can passively invest in large real estate syndication deals for as little as $15-25k. If you are not an accredited investor you can earn great passive cashflow from hard money lending. To become an active investor you need to breakthrough the connections experienced operators have with brokers, establish banking connections, and usually put in a lot of your own capital (or convince investors you know what you are doing without any experience).

12. You’ll sleep like a baby. As mentioned before, you are not responsible for any of the day to day operations. You will not be getting calls if a toilet breaks, electricity shuts off or the appliances stop working. Sleep easy knowing that you have a great professional team looking after that asset and that your operator has factored in the expense of most of these issues happening.

The choice seems easy. If any of these ideas got your brain moving, feel free to shoot me an email or schedule a quick call to learn more.

Happy Investing,

J. Eric Gillem

Everyone's financial situation is different; always discuss your ideas with your lawyer and CPA.

Full disclosure here.