November 16, 2020
Joe Fairless

Active Management Vs. Passive Investing

Investing in real estate can be a terrific wealth building strategy. But did you know that these investments come in two main categories? In fact, active and passive investing offer very different experiences.

Let’s explore these two types of investments. That way, you can figure out which one better suits your needs and lifestyle.

What Are Active Investments?

When you’re an active investor, you spend your own money to acquire a property. You can then offer it to renters while letting a management company handle the maintenance responsibilities, rent collections, and other details.

As you’d probably guess, if you’re an active investor, you can make every decision related to your rental property. Which home will you purchase? Once you own it, how extensively will you renovate it? How much rent will you ask for each month? Will you charge additional fees? Will you try to refinance later on? At what point will you sell this property?

Then there are the tenant-related issues. What will your application process involve, and what are your criteria for accepting new tenants? If you have a tenant who doesn’t pay his or her rent on time, what’s your policy for dealing with that situation? And those are just some of the tricky questions you’ll need to answer.

Obviously, then, to be a successful active investor, you’d need a great deal of knowledge. Or you’d need to do a great deal of research. Either way, you’d have to be confident when it comes to making business decisions.

Of course, active investors don’t just make decisions. They also put those plans into place. And doing so requires due diligence and a lot of time. After all, you’d have to find a property, close the deal, figure out what improvements must be made, hire a management company, and so on.

Later, if any of your tenants complained about their home, you’d have to investigate. If you discovered that your property management company is somehow deficient, you’d need to intercede. You might even end up looking for a new company to work with. In short, this type of investment is extremely complex.

On top of all that, as an active investor, you must be willing to assume significant risk. That’s because you’ll be spending a considerable amount of money upfront, and there are no guarantees.

Indeed, you’re paying for the whole property yourself, and you’re also footing the bill for all of the renovations. And, unfortunately, all kinds of things could go wrong. Your property might be in worse shape than you thought, meaning a much more expensive rehabilitation. Labor disputes, bad weather, and other obstacles could lead to a longer and pricier renovation than you’d expected.

Making matters worse, you might have a harder time finding tenants than you imagined. If there are fewer people looking to rent in your community, it could have a negative effect on your profits. Or perhaps the neighborhood where your property is located suddenly becomes less desirable due to area construction, a natural disaster, or some other unforeseen factor.

Perhaps you simply overestimate how much rent you can collect, or maybe your tenant turnover rate is higher than you predict. In any event, it’s always possible that your property will be somewhat less lucrative than you hope.

On the other hand, your new rental property could be a big success, and it could contribute appreciably to your wealth. Maybe your renovations are minimal, and you can start collecting high rents soon after your purchase. In that case, since you own the property completely, you get to reap the major financial rewards completely.

Furthermore, as the sole owner of the rental property, you can decide when to refinance and when to sell. Passive investors typically have no say in such matters. Also, active investors are often eligible for more tax breaks and benefits than passive investors.

On the flip side, unless you’re a whiz when it comes to home improvement tasks, you’ll have to work with licensed electricians, plumbers, landscapers, exterminators, and other professionals from time to time. The cost of hiring those pros will eat into your profit margins somewhat. It’s something to think about before choosing the active route.

Be aware that other forms of active real estate investing exist. For example, if you buy a property, renovate it, and then sell it at a higher price — a process often referred to as “flipping” — that would be an active investment.

Alternatively, you might take care of all the management duties yourself instead of enlisting a management company. That’s another kind of active investment. Of course, if you were to own multiple rental properties, it could amount to a full-time job.

What Are Passive Investments?

By contrast, when you opt for passive investing, you can make payments to an organization called a syndication. Groups of investors fund syndications. And the people who run it will create the business plan, find the properties to buy, make the purchases, oversee the renovations and maintenance, and take charge of every legal and financial aspect involved.

The right syndication will be adept at choosing a building to buy. It will employ fund managers with deep knowledge of the market and many years of experience. Such individuals know how to evaluate a property for profit potential. They won’t overpay, and they won’t let a good deal slip away.

In sum, the syndication will make every business decision for you, and it will send you a report every month or quarter to update you on your financial gains. It will also deliver to you on a regular basis your share of the profits.

As you can see, you don’t need any knowledge of property management to become a passive investor. You just have to be sure that you’re working with a reputable syndication. Fortunately, you can always seek out a financial advisor for guidance when making that decision.

Because property management experts will make all the decisions and execute all the plans, you face little risk with passive investments. Indeed, at the outset, that team will provide you with financial predictions. Thus, you’ll be able to measure your performance against those expectations, and you shouldn’t have any disappointing financial surprises along the way.

Not to mention, with a passive investment strategy, you can spend only as much as you can afford to lose; other investors will make up the difference. If, for some unexpected reason, your property failed, you wouldn’t face any financial hardship as a result.

The passive approach can widen your investment opportunities, too. For instance, your syndication might have the funding to buy not just one home but a row of townhouses or a sizable office complex. Most people, even high-net-worth individuals, lack the disposable wealth to obtain such a development on their own. And, even if they did have it, they’d be unwilling to put so much money at risk.

However, as with almost everything in life, lower risks mean lower potential rewards. If you’ve invested in a lucrative rental property, you’ll only receive part of the profits. The other investors and the syndication will take their shares as well.

Even so, passive income can really add up over time. As such, it can give you and your family an extra financial cushion. And you have to consider what your time is worth. When you spend so many hours studying the market, locating properties, closing deals, making renovations, finding renters, and so forth, you could be missing out on other wealth building opportunities for your portfolio or other exciting side hustles.

For some people, active investing can lead to increased levels of negative stress, which can have costly health consequences. Plus, there’s another personal cost to consider: All the time that you spend on your active investments is time you could be spending with family members and friends, traveling, or enjoying fun hobbies.

Note that, as a passive investor, you may or may not be able to take your money out of the rental property if you find yourself short on funds. It depends on your syndication’s rules, which you ought to read carefully before making your investment. Additionally, you might want to consult an attorney or another expert if any of those rules are unclear to you.

Similarly, different syndications will offer different systems of fees and payouts. Therefore, it’s wise to do some comparison shopping ahead of time. That way, you can be certain that you’re getting a favorable arrangement.

In the end, both active and passive investments offer the chance for steady, reliable income. The active option can provide much more income, but it’s also significantly riskier as well as more work-intensive and more time-consuming.

For its part, the passive avenue is simple, almost unbelievably easy. With a dependable syndication making the choices and doing the work, all you have to do is invest your money and collect your passive income checks. It may sound too good to be true. But it’s very real, and it makes a real estate investment an appealing option for just about anyone.

DisclaimerThe views and opinions expressed in this blog post are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.  

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