I first started my real estate journey with rental properties in Atlanta. I still manage many of them, mostly because I have low-maintenance tenants and do not often get the dreaded 3 am calls about toilets or termites. However, I have heard horror stories and understand why being a landlord is not suitable for every investor!
Even with multiple single-family investment homes rented out across my community, I was not seeing the passive income I hoped I would see from owning and managing numerous single-family houses.
I decided to continue my real estate investment quest and found another way to invest. Seek, and ye shall find, right?
I discovered another way to invest in real estate without buying more houses or spreading myself even more thinly as a landlord, which was a breath of fresh air because I didn’t know there was another option.
In this article, you’ll read all about real estate investing and receive more information about active investors vs. passive investors.
What It Means To Be An Active Investor
When most people think of real estate investing, they think of rental property investing – buy a single-family home, find a renter, and collect monthly rental income. Sounds easy enough, but the reality can be quite different.
Even with a professional property management team on board, you as the landlord still have an active role in the investment.
The property managers may take care of the day-to-day issues. However, you will still need to be involved in strategic decisions, including evicting tenants who aren’t paying, filing insurance claims when surprises happen, and sometimes putting in additional funds to cover maintenance and repair costs.
What It Means To Be A Passive Investor
On the flip side, passive investing is the “set it and forget it” type of real estate investment. You invest your money, and someone else does all the heavy lifting.
The significant part about passive investing is that it’s totally passive – you don’t get any calls from the property manager, you don’t have to screen any tenants, and you don’t have to file any insurance paperwork.
However, being a passive investor also means that you relinquish some of your control in the investment and trust someone else (i.e., the sponsor team) to manage the property and execute the business plan on your behalf.
Should You Be an Active or Passive Real Estate Investor?
Here are ten factors to help you decide which path is right for you.
#1 – Tenants, Termites, Toilets, and Calls at 3 AM
If you’ve dreamt of becoming a landlord, having tenants, and making improvements, then consider an active investor role.
Otherwise, if the title to this bullet point makes you nauseous, you should go the passive route.
#2 – Time
Active real estate investments require more time during the initial acquisition and throughout the project lifecycle, while passive investments only require your time upfront during the research phase.
#3 – Involvement
How hands-on do you want to be? Do you want to manage the property yourself, field tenant requests, and schedule maintenance and repair appointments? Or do you want to sit back while someone else does all of that?
#4 – Profits
With active investing, you would likely be the only owner of the property, so you would get to keep any net profits. With passive investing, the profits are distributed among many investors.
This doesn’t necessarily mean that one type of investment will net you higher returns than the other; you’ll need to compare one deal to another.
#5 – Expenses
Active real estate investors should plan to handle insurance claims, emergencies, and repairs, which may require additional money at times, whereas passive investors only make an initial capital investment.
#6 – Risk and Liability
With active investing, if things go south, you are personally held liable, which means you may lose the property and your other assets.
With passive investing, your liability is limited to the capital you invest. Typically, the asset is held in an LLC or LP. If anything goes terribly wrong, the sponsors are held liable, not the passive investors.
#7 – Paperwork
Active investments are paperwork-heavy, from the initial purchase of the property to tracking purchase and rental agreements, bookkeeping, and legal documents throughout the project.
On the other hand, with passive real estate investments, you typically sign a single PPM (private placement memorandum) to invest in the property. There is no need to fill out lender paperwork, file for insurance, or do any bookkeeping.
#8 – Team
As an active real estate investor, you will need to build your team, including brokers, property managers, and contractors.
As a passive investor, you rely on the shared expertise of the existing deal sponsor team. The sponsors are experts in the market and typically already have a group arranged to manage the property.
#9 – Diversification
With active investing, you need to be an expert in the market and asset class you’re investing in. If you’re investing outside your local area, you need to research the market, find a “boots on the ground” team, and possibly visit the area.
With passive investing, it’s easy to diversify across different markets since you don’t have to start from scratch with each market. Instead, you are investing with teams that have already taken the time to research those markets and build strong local teams.
#10 – Taxes
As an active investor, you’ll be responsible for the bookkeeping, meaning that you will need to keep track of the income and expenses. You’ll also need to work with your CPA to make sure that you are correctly depreciating the asset’s value each year.
As a passive real estate investor, you don’t need to do any bookkeeping. You receive a Schedule K-1 every spring for your taxes, which shows the income and losses for that property—no need to track income and expenses throughout the year.
Making The Right Investment Decision For You
If you are the ‘roll up the sleeves, I will fix it myself’ type (or have a connection who will fix it for you), being a landlord and an active investor might be a perfect choice for you. Rentals are great for DIYers and folks who love the down-and-dirty adventures in hands-on real estate.
However, you have the capital to invest and your time is limited, but being hands-on and having to help tenants at all hours of the night or figuring out a landscaping plan seems like a lot, you may want to consider becoming a passive investor.
If you are looking at both options and wishing you could put your money into both. There is a middle option. You could invest in turnkey rentals and buy-and-holds, and these types of investments give you some control without the time commitment.
Always factor in your unique situation, goals, and interests, and these should help you determine the right path for you.