You can divide real estate investors into two categories: active investors and passive investors. Both approaches can help you earn additional income and build long-term wealth. However, depending on your goals and a couple of other key factors, one path will be better suited for YOU than the other.
In this article, we’ll break down the pros and cons of active versus passive real estate investing, so you can decide which method is right for your vision of success.
Active Real Estate Investing
Active real estate investing involves securing your own financing to buy one or more properties so that you can rent them out or fix them up and flip them for a profit. “Active” is the key word here, because you’ll be involved in a very hands-on way at some level in purchasing, repairing, improving, and/or selling your investment property.
As this is your venture, you will be fully in control. You can decide if and when to sell the property and whether or not to make improvements. You can pick your own tenants and set the rental rate. You may also save money on vendors and services, if you decide to do some of the work yourself. If you enjoy the satisfaction of making decisions on your own or can’t contemplate others affecting your investment, this control works in your favor.
Greater Share of the Profits:
Because you purchase the property with your own money and don’t have partners or investors to share with, you won’t be splitting the profits with other investors or fund managers. Note, however, that the total profit may not necessarily be higher if you are an active investor rather than a passive investor. You will simply get a larger share of whatever profit there is at the end of the day. And that leads us to…
You are taking on much more risk than with passive real estate investing, because you will be solely responsible for absorbing any and all losses that occur. With a pooled investment, your share of the loss may sting a little, but then you could easily rebound from it. But as an active investor acting on your own, the impact can be much more resounding. Also, with only one source of capital or financing, you are most likely limited to purchasing one or maybe two properties rather than diversifying and spreading the risk across a portfolio.
Higher Time Commitment:
Congratulations: Like it or not, in buying a property as an active investor, you are now a landlord. This is an enormous responsibility and time commitment. You will be responsible for building maintenance, placing tenants, negotiating leases, ensuring legal compliance, and setting the right rental price. If you outsource these tasks to a property manager or other vendors, you will still have to take time choosing them and remain the chief decision-maker at the end of the day.
Higher Startup Capital:
Because you are putting up the money for the investment yourself, it takes more capital to jump in as an active investor. Raising the money could involve using your personal possessions as collateral, which could be stressful for you and/or your family.
Limited to Certain Locations and Types of Properties:
If you are managing the property yourself, you’ll need it close at hand. This could limit your potential returns. For instance, your local real estate market may not be appreciating at quite as high a rate compared to an emerging market farther away outside of your region.
Also, as an active investor relying on your own financing, it’s unlikely you can afford to purchase larger-scale properties. This limit in your purchasing power could force you to buy only what you can literally afford and therefore hold you back from investing in big spaces with excellent returns, like apartment complexes or commercial office space.
Passive Real Estate Investing
Passive real estate investing is when you pay a 3rd party (e.g. a real estate investment and management fund like Birchstone Investments) a portion of the future profits to find, purchase, and manage one or more investment properties. You will be pooling resources along with other investors into acquiring multiple assets.
Because you are contributing to a pooled fund, multiple properties will be involved in the investment instead of just one or a few. That way, you can diversify your portfolio and spread out the risk.
Experienced professionals will handle everything from purchasing to leasing and ongoing management. This lowers the odds of overpaying for a property or underpricing your rental, which can adversely affect your profits.
Lower Time Commitment:
Though you own a stake in the property, you will not be performing a landlord’s duties. Professional managers, repair companies, etc. will handle these on your behalf, saving time.
These vendors may come at a negotiated discount over hiring them yourself, and you won’t be taking the time to compare rates, vet their competence, and judge the quality of their work.
Lower Threshold for Starting Capital:
Because you’re splitting the financing with others, you can enter these investments with less capital than active investing.
Access to a Wider Range of Properties:
Because you don’t have to assess or manage the property yourself, it does not have to be close to where you live. This opens the opportunity to acquire property in a distant market with higher potential appreciation.
By pooling your funds with other parties, you’ll be able to invest in more expensive, larger properties, such as multi-unit buildings and commercial spaces. These investments generally offer stronger potential profit than the smaller rentals most active investors can afford on their own.
Lower Share of the Profits:
Unlike active investing, the profits will be shared with other investors as well as fund managers, who will take a portion for their work.
You won’t be able to decide if and when to sell, what improvements to make on the property, or which tenants occupy your building. Your properties will likely be far away, and it might be uncomfortable to hold a stake in assets you never physically go to or make decisions about.
Which Method is Right for You?
Investors with a large amount of capital and significant real estate experience can succeed as active investors. Inexperienced investors who have time and disposable capital and are willing to swallow the learning curve can make this method work as well. In both cases, it is still a high-risk venture where the downsides make it a gamble.
It’s important to note that a lower share of profits is not necessarily a lower return on investment. Considering professional knowhow, access to multiple and a higher class of properties, time savings, and buying into potentially a hotter real estate market, passive investing offers so many upsides that we believe it’s right for the vast majority of investors.
If you’re interested in learning more about passive real estate investment, contact our team here at Birchstone Investments. We bring you the benefits of investment-grade multifamily real estate without the headaches of having to deal with day-to-day property operations.