Friday, October 25, 2019

Active versus passive real estate investing

By Dan McDermott

Individual private investors who are looking for a reliable stream of income often turn to real estate and face an age-old question: Is it better to be an active or passive real estate investor?

Given real estate investments inherent ability to provide steady passive cash flow from rents or loan payments plus some very generous tax benefits, it is not a wonder why they are a popular investment vehicle.  Additionally, there may also be a worthy prize at the end too; the potential to realize capital appreciation and possibly double or even triple your investment. This combination produces higher returns than traditional passive income sources such as bonds or dividend-paying stocks.

When investors decide whether to pursue real estate investing on either an active or passive basis, they need to consider the pros and cons of each strategy. In order to determine which investment strategy is best for you, you should first understand the main differences between the two.

Active investing is when an investor directly purchases a property for rental cash flow or to fix and flip for a profit. The property could be anything from a commercial building to a single-family house or a large multifamily property. The investor will personally manage all aspects of the investment process. This includes finding the deal, negotiating the deal, securing the financing, closing the deal, and managing the investment. The process of identifying a suitable market, property, financing can be time consuming and complicated.  However, it can also be very rewarding and if the investment goes well, the investor will get to keep the largest share of the profits.

Passive investing is a hands-off approach which allows an investor to place one’s capital into a real estate vehicle – more specifically, an apartment, commercial, or self-storage syndication – that is managed entirely by a management company. Investing passively in real estate means the investor outsources the acquisition and management of their real estate investment to a management company.  The management company pools together many investors capital and buys larger or even entire portfolios of properties. The management company is responsible for the day-to-day operations of the properties and charges a fee for their services. The investors will then get a monthly or annual share of the profits earned from the rents collected on the property or portfolio of properties.

Based on my experience in working with active and passive real estate investors, I think there are many important factors to consider when deciding which investment strategy is right for you. One of the most important factors is control.

Most investors consider an investment to be either active or passive depending on the level of control you have.  As a passive investor you are opting to relinquish most of the control to an experienced management company who will use your capital to acquire and manage a portfolio of properties. When you give up control, the investor is putting a lot of trust in the management company to execute the goals/business plan of the investment.

As an active investor, you can directly control the nature of the investments you make. You decide which investment strategy to pursue. You decide the type and level of renovations to perform. You decide the quality of tenant to accept and the rental rate to charge. You determine when to refinance or sell. With passive investing, all of the above is determined by the management company.  

Normally from an investment fit an investor is either active or passive, but not both, and it usually comes down to whether the investor wants to have control or not.

In the end there are many ways to become a successful real estate investor. Not all strategies are the same, so it's important to understand the pro's and con's and to identify which path (active or passive) is best for you.  If you have any questions or are interested in learning more real estate investing, please contact me today at 207-712-3152.

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