When I first started investing in real estate, I thought that buying rental properties and becoming a landlord was the key to generating passive real estate rental income.
So, I invested in one rental property after another in my quest for financial independence, but it quickly hit me that the more properties I had, meant more of my time was committed to actively fielding calls, coordinating repairs, and making decisions about each.
I was after passive income, but this didn’t feel at all passive. On the contrary, I was working harder than ever and juggling what felt like two lives.
That’s when I discovered that you could actually invest in real estate without becoming a landlord! It’s true – you can get all the benefits of investing in real estate without any of the hassles of being a landlord.
In this article, you’ll learn the pros and cons of passive and active real estate investing, what it means to be a passive investor, and get an overview of real estate investing cash flow, taxes, diversification, and other details about active vs. passive real estate.
If you’ve been on the fence, unsure about whether passive real estate investing is right for you, you’re in the right place!
What Is Active Real Estate Investing?
When most people think of real estate investing, they think of residential rentals – 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 evictions, insurance claims, and sometimes having to contribute additional funds to cover maintenance and repair costs.
What Is Passive Real Estate Investing?
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 great 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 whether active vs. passive real estate investing 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.
Take this tip from one active real estate investor to another, that you’ll need to assemble a team of professionals to help manage and maintain your properties. In some cases, this means hiring a property manager.
If you prefer to avoid the 3 am backed-up-toilet phone calls, don’t know the first thing about screening tenants, and want nothing to do with bugs, you should go the passive route.
#2 – How Much Time Do You Have For Real Estate?
Active real estate investments need more time and attention throughout the project’s lifecycle, while passive investments only need your time and attention at the beginning. Actively managing real estate can quickly become a full-time job.
For most people, becoming a real estate investor is a step toward increased income and less work. If this is you, you’ll want to lean toward opportunities that are considered passive and away from those considered active.
#3 – What Level Of Control Do You Prefer To Have Over Your Investments?
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?
As an active real estate investor, you are entirely in control, from the selection and development of the property to the management of tenants or sales.
However, passive commercial real estate investors rely on a team of seasoned professionals familiar with your investment property’s precise asset type, value-add cost benefits, and market cycle.
If you don’t have the time, energy, or desire to be involved in the day-to-day purchase, renovation, repairs, and maintenance of your rental properties, passive investing may be a better option for you.
#4 – Active And Passive Income – What’s The Difference?
In active real estate investing, you’re likely the only owner of the property, so you would get to keep all net profits. That seems fitting since you essentially take on a full-time job to find, fund, and manage everything about making each of your properties cash flow. Thus, you trade your time and energy in exchange for active income.
With passive real estate investing, net profits are distributed among the partners and investors. In a real estate syndication, for example, hundreds of passive investors can pool their money together to fund the purchase of a large commercial property.
On passive real estate investment deals, the sponsor team takes care of acquisition, property management, financial matters and follows the business plan to increase income for investors while creating an improved living situation for the community. Meanwhile, you sit back and relax as your money generates money, which is considered passive income.
This doesn’t necessarily mean that either passive real estate investing or active real estate investing will net you higher returns than the other; you’ll need to evaluate each deal’s risk, local market, and metrics.
#5 – How Much Additional Money Can You Throw At Your Real Estate Properties?
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.
Unforeseen circumstances pop up in every investor’s journey, but this is one of the main dividing factors of active vs. passive real estate investing. As an active investor, you need reserves to handle excess financial obligations, and you should plan on driving all claims, coordination, reports, and complaints yourself.
However, your passive real estate investment requires little-to-no additional commitment. The sponsor team handles everything, and while you’ll likely get updates, there’s nothing for you to control or do.
#6 – Active vs. Passive Investors’ Risk and Liability
With active real estate investing, you are personally held liable if things go south, which means you may lose the property and your other assets. Residential real estate can be tricky based on location, local laws, and geopolitical moves outside your control. I know you’ve seen the heartbreaking homeless landlord stories, and this is why – because active investing carries the most risk.
On the other hand, passive real estate investments limit your liability to the amount of capital you invest. Typically, the asset is held in an LLC or LP. If anything goes wrong, the sponsors are held liable, not the passive investors.
#7 – Do You Have An Affinity For Real Estate Paperwork?
Active investments are paperwork-heavy, from the initial purchase of the property to tracking purchase and rental agreements, bookkeeping, insurance, and legal documents throughout the project. What’s worse is the paperwork restarts with every turnover.
Alternatively, with passive real estate investments, you typically sign a single PPM (private placement memorandum) to invest in the property. No need to fill out lender paperwork, file for insurance, or do any bookkeeping. You’ll receive simple documentation during tax season to help your tax professional report your passive income correctly.
Real estate investing can be active or passive. Still, it is usually more paperwork-intensive to actively invest in real estate than it is to passively invest in real estate.
#8 – Are You Willing To Build And Manage Your Team?
Active and passive real estate investors need a team – it’s just impossible to properly work a real estate investment flying solo.
As an active real estate investor, you will need to build your own 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 team set up to manage the property.
#9 – What’s Your Diversification Plan?
With active investing, you would need to be an expert in each 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 site.
With passive investing, it’s easy to diversify across different markets since you don’t have to start from scratch with each deal. Instead, you are investing with teams that have already taken the time to research those markets and build strong local teams.
#10 – Active Vs. Passive Real Estate Investing 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 value of each investment asset 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.
The Pros and Cons of Active And Passive Real Estate In A Nutshell
Active real estate investing is great if you have one property that you want to handle on your own, either as an owner-operator or with a management company. This gives you more control over the cash flow, rents, vacancies, and property sale. But this means that you’re ultimately responsible for all aspects of the business from acquisition to tenant screening and turnover, property management during ownership, and even project marketing when it sells. Advantages for small investors include “doing it yourself” and avoiding fees and commissions.
Passive real estate investing through real estate syndication deals is the best way to invest, in my opinion. These passive investments require only $50,000 on average as investment capital (with the potential for a seven-figure return), virtually no work, and little risk.
This includes syndicated deals with Gibby’s Investor Club, where we aim for you to simply receive cash distributions from profits without having to do anything yourself. You don’t have to worry about paying contractors or finding new tenants since our sponsor team will cover all of these tasks and more.
You’re here because you know you want to invest in real estate, but now you have a much more comprehensive view of what it means to be on either side of the active vs. passive investor pool.
As you dive deeper into real estate investing, consider the lifestyle you want, how interested you are in becoming a real estate professional, and what your real estate investment goals are.