According to Gallup, most Americans favor real estate over any other form of investment – it even beats stocks and bonds.
How should you invest in real estate, though? That’s another story. From house-flipping to REITs, there is a wide range of investment options. In “investment speak” we might break these out into two groups: active vs. passive investing. The distinction between these forms of investments matters greatly, as it impacts how knowledgeable or involved you need to be to invest.
Active and passive are common ways to segment different types of investing (for example, bonds or “set it and forget it” mutual funds are considered passive, while day trading is considered active).
In this article, we’ll examine passive vs. active real estate investing in more detail and show you how investing passively in real estate might be the right choice for your portfolio.
What is passive investing?
Passive investing can be done without consistent involvement or management. Passive income is income you make from a passive investment. In other words – income you make without having to do much of anything.
Active investing requires direct involvement – think picking stocks or seeking out arbitrage opportunities. Passive investing, though, has a much lower barrier to entry and is much easier to balance because it does not require active management.
So how do passive real estate and active real estate investing differ? Let’s examine that in detail.
Passive vs. active real estate investing.
House-flipping, managing properties yourself, or seeking out arbitrage opportunities are all active forms of real estate investing. Each requires your involvement and can become time-consuming.
Passive investing differs in forms that do not require direct involvement or active management. We’ll examine three of the most common options in detail.
What are the forms of passive investing in real estate?
Passive investing is a fairly broad term in that there are many ways to passively invest and build income from real estate. For now, we’ll examine the three most common ways to build passive income through real estate.
REIT stands for real estate investment trust, a common way to break into real estate investing. REITs allow you to invest in real estate as you would the stock market. REITs allow you to purchase shares in commercial real estate portfolios, allowing you to diversify your portfolio and build passive income through dividend payments.
REITs are not without risks (as is the case with any investment), but they are a good option for passive investors looking to break into real estate.
Owning a property
Owning and renting/leasing a property is another great way to build passive income through regular rental payments. By working with a property management company you can even remove yourself from the property, benefiting from the rental payments without having to worry about managing tenants.
Owning a property is not without its downsides, though. For one, there is a higher barrier to entry than in REITs because you need to be able to purchase the property (rather than simply invest in it). You have to do your own due diligence on the property’s condition and value, the market, and the demographics. You also need to worry about filling the property with qualified tenants, as well as making a profit after mortgage, insurance, property management payments, and upkeep expenses.
Real estate syndication
If you’re looking for the “best of both worlds” rather than a REIT or directly owning a property, a real estate syndication may be the answer.
A real estate syndication can be a fund or a group of investors that purchases a property (or series of properties), which then generates passive income for the investor through rental payments and the eventual sale of the property. Like a REIT, it allows you to invest in real estate without having to purchase a property, and like directly owning a property, you get to benefit from the eventual sale.
Real estate syndications are an excellent way to diversify your portfolio and build passive income, though, like any investment, they carry risk. There is also a barrier to entry to them, as you usually need to be an accredited investor to be eligible.
If you are an accredited investor who wants to build passive income and owning a property seems like too much hassle (and we don’t blame you!), investing in a real estate syndication may be a great option.
What are the benefits of passive investing in real estate?
We hinted at these above, as there are many benefits to passively investing in real estate. Let’s examine the top benefits.
You can build passive income.
Unlike popular investments like stocks which can generate a return on sale (outside of dividends), real estate affords you a return on the sale of the property and potential passive income through rental payments during the investment period. If you ask us, this is one of the best benefits of investing in real estate compared to other forms of investing.
Directly owning a property will make you the sole receiver of these rental payments (after clearing expenses, of course) providing your property is occupied, but you’ll still receive regular passive income from a real estate syndication.
Less knowledge needed
As we said above, active investing requires more knowledge and experience to succeed – there’s just much more room for error. Meanwhile, passively investing in real estate requires less experience and can be balanced easily with the rest of your portfolio (not to mention your day job).
For investments like a real estate syndication, you will need to be an accredited or sophisticated investor, while investing in a REIT or owning a property has no eligibility requirement (other than to qualify for a mortgage if you plan on purchasing a property).
Less involvement required
Passive investing requires far less time, involvement, and management on your part. That is the beauty of it. Outside of deciding on where to invest, there is not much more you need to do.
Investing in real estate has tax advantages.
Real estate investing offers extra tax benefits depending on how the value of the property changes, and your role in investing in it. We’ve covered the tax benefits of investing in a real estate syndication to give you some idea as to how you can benefit.
What are the risks of passive investing in real estate?
While investing in real estate can be a great way to build passive income, there are risks (as is the case for any investment).
Investing in real estate carries risk in that are no guarantees that a property will increase in value. The closer you are to a property, the more at risk you are. Directly owning a property is a great way to build a passive income stream; however, you then need to worry about filling it with tenants.
You can reduce risk by adding more distance between you and the property, such as a REIT or real estate syndication, though that will not eliminate market risks.
Keys to success in passive investing in real estate
Interested in building passive income through real estate? Here are some keys to success. These are not guarantees that you will make money as much as they are tips to help you choose the best investment for your goals and tolerance for risk.
Choose the right market.
The market you invest in is critical, especially with real estate. As with any other investment option, investing in the right market can make or break your investment. In real estate terms, this comes down to the location and type of property/properties you invest in. Working with a firm that you trust to help make these decisions can reduce risk or, at least, take it off your plate.
Know your risk tolerance.
As is the case for any investment, you need to understand how much risk you are willing to take on, how much you are willing to invest, and how liquid your investment is (how quickly you can convert it to cash). Owning a property and syndications are not liquid, while REITs may be converted to cash more quickly.
Do your homework before investing.
As with any investment, it’s important to do your research. Real estate is an excellent way to diversify your portfolio and build passive income. However, that does not mean every investment choice is the same or that every choice you make is foolproof. It’s also important to understand what you are investing in, and investing with a firm you trust will make the right decisions for you and guide you through the process.
Is passive investing in real estate right for you?
Real estate syndications provide numerous benefits and advantages when investing in commercial real estate while remaining removed from managing the property yourself. While returns cannot be guaranteed, a real estate syndication could generate stable passive income and a profit for its investors.
At Colony Hills Capital we are experts in the acquisition, ownership, and management of property in growing markets around the country. While we cannot guarantee results, we always aim to provide consistent and above-average passive income to our investors. Past performance is no guarantee of future results.
Interested in investing? Contact us today to learn more.