A Guide to Passive Real Estate Investing

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Contributor, Benzinga
February 14, 2024

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Andrew Carnegie, an industrialist in the late 19th and early 20th centuries, is widely regarded as one of the richest men in American history. His quote, "Ninety percent of all millionaires become so through owning real estate," continues to be relevant in today's world. Carnegie's advice to invest in real estate still holds true for several reasons.

Firstly, real estate provides a reliable means of asset protection. Unlike other forms of investment, such as stocks or bonds, real estate investing can offer a tangible and physical asset that is less susceptible to market volatility. This stability offers individuals a sense of security, especially during economic downturns or financial crises. Moreover, owning real estate can also serve as a hedge against inflation since property values tend to increase over time.

Secondly, investing in real estate entails lower transaction costs compared to other investment avenues. While there may be initial expenses such as down payments and closing costs, the long-term benefits outweigh these costs. Additionally, real estate offers tax advantages such as deductions for mortgage interest and property taxes, which can further enhance its appeal as an investment option.

Lastly, real estate is an essential asset class that fulfills a basic human need: shelter. Regardless of economic conditions, people will always require housing. By investing in real estate, individuals can capitalize on this perpetual demand and enjoy a steady cash flow through rental income. Furthermore, they can also potentially benefit from property appreciation over time, leading to significant returns on their investment.

Thus, through passive real estate investing, individuals can potentially secure their financial future and build wealth over time. Let's dive into how you can start investing.

What is Passive Investing?

Passive investing, also known as passive management or index investing, is a strategy where investors aim to replicate the performance of a specific market index or benchmark. Instead of actively selecting individual stocks or trying to outperform the market, passive investors seek broad exposure to a given market by investing in low-cost index funds or exchange-traded funds (ETFs).

The main principle behind passive investing is the belief that the market as a whole is efficient, implying that it accurately reflects all available information and is not easily predictable. This idea is supported by the efficient market hypothesis, which suggests that it is difficult, if not impossible, to consistently outperform the overall market over the long term.

What is the Difference Between Active and Passive Real Estate Investing?

Perhaps the oldest and most traditional method of real estate investing is active real estate investment. In this method, active investors make direct investments where they buy an income property and then act as the property manager on a day-to-day basis.

They are the point of contact for the tenant and take responsibility for collecting the rent, arranging maintenance and showing vacancies. This type of active investor is often referred to as a mom-and-pop landlord because historically, active investors like this have been husband-and-wife operations. However, hiring a property manager can provide a more passive income approach to real estate investing.

They usually have between 2 to 10 units earning rental income for them and handle the management to save money. Although you may first think of large, multi-unit apartment complexes when you think of landlords, most landlords in the U.S. who are active investors fit into the mom-and-pop category. They scout out a few real estate opportunities over time until they grow a small-to-medium-sized portfolio that earns solid rental income.

But that’s not the only kind of active real estate investment. Developers and home flippers buy and renovate single-family homes, commercial real estate or entire apartment buildings. Then these active investors supervise the property renovations on a daily basis. They choose the property and the level of luxury they’re going to rebuild with, all with the intent of adding value to the property and selling it at a profit.

Both of these methods of active real estate investing are well-proven. They’ve made active investors a lot of money over time, and they will continue to do so. It allows investors to exercise a level of control over their properties and that peace of mind is important to them. With that said, real estate investment does have some significant drawbacks.

First, it’s time-consuming. Tenants don’t just have problems during business hours. Being a landlord is a 24-hour, 7-day-a-week job. It takes a great deal of skill and knowledge to be an active investor who flips properties for profit. In both the case of the landlord and the flipper, you need to develop specific skills and be prepared to spend lots of hours managing your real estate investments.

If that sounds like too much work for you, you’re not alone. Fortunately, there is another way: passive real estate investing. Passive investors employ a different investment strategy. They own rental properties, but they don’t deal with tenants. They don’t show vacancies or arrange maintenance. In fact, passive investors rarely if ever even see the properties they make money off of. How do they do this? Keep reading to find out.

Advantages of Passive Real Estate Investing

Passive real estate investing has emerged as a popular investment strategy among individuals seeking to diversify their portfolios and generate a steady stream of income. Unlike active real estate investing, which requires hands-on involvement in property management, passive investing allows investors to have a more hands-off approach. There are several advantages to passive real estate investing that make it an attractive option for both beginner and experienced investors.

One of the key advantages of passive real estate investing is the opportunity to earn passive income. By investing in rental properties or real estate investment trusts (REITs), investors can enjoy a consistent monthly cash flow without having to actively manage the property. This passive income can be a valuable source of stable cash flow, especially for individuals looking to supplement their primary income or build a long-term wealth-generating asset.

Another advantage of passive real estate investing is the potential for long-term appreciation. Real estate has historically been a reliable investment that tends to appreciate over time. By investing in properties located in high-demand areas or emerging markets, investors can take advantage of property value appreciation and benefit from increased property values over the long term. This appreciation can result in significant capital gains and lead to substantial wealth creation.

Additionally, passive real estate investing provides investors with diversification opportunities. Real estate assets have a low correlation with traditional asset classes like stocks and bonds, making them an effective way to diversify an investment portfolio. Diversification helps spread risk and reduces the impact of a single investment on the overall portfolio. As a result, passive investing in real estate can enhance risk-adjusted returns and provide stability in times of market volatility.

Risks of Passive Real Estate Investing

Passive real estate investing has become a popular option for individuals looking to generate passive income and diversify their investment portfolio. However, like any investment strategy, there are risks involved that potential investors should be aware of before diving in.

One major risk of passive real estate investing is the lack of control. When investing passively, you rely on the expertise and decisions of others, such as real estate developers or fund managers, to choose and manage the properties. This means you have limited control over how the investment is handled, including decisions on property selection, renovations or maintenance, and rental management. If the individuals in charge make poor decisions or mismanage the property, it can result in financial losses for passive investors.

Another risk is the lack of liquidity. Real estate investments are typically long-term commitments, and passive investments are no exception. Once you invest in a real estate project, it may take years before you can see any returns or have the ability to sell your stake. This lack of liquidity can be a disadvantage, especially if you need access to your funds for unexpected expenses or other investment opportunities.

Further, passive real estate investing is subject to market fluctuations and economic downturns. Real estate markets can be unpredictable, and property values can fluctuate significantly over time. Economic downturns or changes in the local real estate market can negatively impact the performance of passive real estate investments, leading to potential losses.

How to Become a Passive Real Estate Investor

The money generated by the properties in a passive investor’s real estate portfolio is known as passive income. It gets this name because the investor can generate income without actively or directly managing any of the assets in their portfolio.

If you want to invest in real estate passively, you can use a number of methods to accomplish this. This investment opportunity allows fund managers to gather the crowdfunding they’ve collected, build a portfolio and generate income for every investor.

Online Crowdfunding Platforms

Crowdfunding is all the rage these days, but it’s actually a very old concept. Anytime you pool money with other investors to buy real estate, you crowdfunded that deal. For example, if you and your girlfriend both put together $50,000 to make a down payment on a house, that’s crowdfunding. It’s a small crowd, but it’s a crowd.

Before real estate crowdfunding platforms, this concept was practiced with real estate syndication. The syndicator finds the opportunity and negotiates the deal, while individual investors put up most of the capital in exchange for a share in the equity and cash flow from the investment property. The syndicator then handles the management while the investors simply collect a passive income stream. Real estate syndication is most popular with multifamily real estate and commercial real estate.

Real estate crowdfunding platforms expand on that concept. They have large portfolios of different real estate offerings with buy-ins ranging from as low as $100 to $100,000. Usually, crowdfunding platforms allow you to take partial ownership of commercial properties - although some platforms have single-family home offerings - and you get distributions from the rental income. These distributions are typically paid out on a monthly or quarterly basis.

You can pick and choose the properties you want to invest in based on your own intuition and preferences. Regardless of what properties you add to your portfolio, they will be managed by the project sponsor. You don’t take phone calls or tenant complaints. If it all works, you just sit back and enjoy your distributions.

Equity Real Estate Investment Trusts (REITs)

An equity REIT is a fund or corporation that uses a combination of the fund’s capital and investor contributions to purchase income-generating properties in multiple markets. In that way, the real estate deals that REITs conduct are also crowdfunded, but unlike crowdfunding platforms, REIT investors don’t directly choose what properties they will invest in.

In real estate investment trusts (REITs), investment decisions and the management of day-to-day operations are taken care of by the property manager. REITs typically target underperforming commercial properties like apartment complexes in markets that are growing but haven’t reached the peak of their growth cycle.

Once a REIT acquires a property, it usually institutes a series of planned upgrades - such as remodeling units and improving the common areas - with an eye toward increasing both the revenue generated by the property and the property’s overall value. Throughout this time, REIT investors earn regular passive income and hopefully get an even larger payout when the REIT sells the asset.

Aside from the chance to earn income in two different ways, REITs offer passive investors a host of other advantages. Specifically, REIT shareholders get to make annual depreciation write-offs against their income and since the money they earn from the REIT is classified as pass-through income, shareholders can take a 20% write-off annually. All of this makes equity REITs one of the most popular passive investments in the real estate asset class.

Mortgage REITs and Hybrid REITs

Although equity REITs are the most well-known kind of REITs, they are not the only kind. Mortgage REITs pool investor contributions to buy mortgages or mortgage-backed securities. They also borrow money at low interest rates for the purpose of lending money at a higher interest rate than they pay on the money they originally borrowed. Real estate investment trust also offers investment opportunities for passive income seekers.

Mortgage REIT investors profit from the money earned by the accrued interest. Mortgage REITs don’t usually offer as much growth as equity REITs because the interest rates are fixed and there isn’t an upside in raising rents like there would be in an equity REIT.

Mortgage REITs are secured by the properties they finance, which means investors will still have an asset to liquidate in case of a borrower default. These investors may see less income but experience less volatility since the loans are secured by real estate.

For passive investors who want the best of both worlds can invest in hybrid REITs. A hybrid REIT will have its investment capital split between equity investments and mortgage securities. The risk is comparatively lower than an equity REIT, but the potential income and long-term upside are a bit higher than a traditional mortgage REIT.

Real Estate Funds

Passive investors can also choose from a number of different real estate investment funds, which are sometimes known as mutual funds. Instead of buying properties, real estate funds tend to build a diversified portfolio of real estate-backed securities. Whereas some REITs may focus mainly on multi-family properties or industrial properties, mutual funds tend to spread capital across different real estate assets in several different sectors.

The long-term profit potential in real estate funds is not necessarily in monthly or quarterly distributions but in the appreciation of the assets in the fund. As those assets appreciate and reach peak value, they are sold off and the profits are distributed to the fund shareholders. In almost all cases, real estate funds are managed by an experienced team of real estate professionals. Passive income is a key aspect of real estate funds, where the profits are generated through renting properties.

Theoretically, real estate investment funds offer passive investors a set-it-and-forget-it option where they can invest their money in a highly diversified portfolio of real estate assets and just wait for the dividends. However, investing in these funds requires investors to have tremendous confidence in the fund manager who will be choosing all the assets and making all the decisions.

Remote Real Estate Investing

Remote real estate investing is another way for passive investors to earn income from making direct investments. In remote real estate investing, you would identify assets like apartment buildings, industrial centers or storage spaces; buy them; and then turn them over to a property management company to run on a daily basis.

The management company collects rent, interfaces with tenants and takes care of the maintenance, usually in exchange for a percentage of the gross rent. Typical management fees range between 3% and 6% of the monthly rent generated by the property. Passive investors can choose this option for properties in their immediate area or properties located in other states.

Remote real estate investing gives passive investors a higher level of control over what assets they choose and who will be managing those assets, while also freeing them from the time constraints of day-to-day management. It’s a popular way of passive real estate investing.

Buying Trust Deeds and Notes

Every investor has a different idea of what is an ideal real estate investment. For some investors, the idea of waiting for people to pay rent or hoping a developer will complete a renovation and sell an asset at a profit is just not their cup of tea. They may want something more secure even if it generates less income.

For passive investors who want a little more security and direct control over what assets are in their portfolio, buying trust deeds and notes is a proven method of passive real estate investing. It’s basically what it sounds like. Trust deed investors buy notes from mortgage and lien holders for less than the remaining value on the note. They take over the note on the property and become the new mortgage holder, meaning the borrower pays them back instead of the original lender.

If the borrower defaults, the real estate trust deed holder can call in the note and foreclose on the property. At that point, they can sell the asset and once their capital is returned, they are free to purchase another trust deed.

How Much Does it Cost to be a Passive Investor in Real Estate?

Historically, the high cost of real estate has been the single biggest barrier to acquiring it. That’s why crowdfunding platforms, REITs and mutual funds were conceived. Minimizing investor risk by raising capital through a wide range of sources is a win for everyone.

However, even within that framework, many of the highest-performing passive funds and private REITs can have six-figure buy-ins and are only available to accredited investors. Fortunately for investors, online crowdfunding platforms and a change in investor eligibility standards at the federal level have opened the playing field for non-accredited investors. Crowdfunding platforms with passive real estate offerings start as low as $100. Real estate investing has become more accessible due to these changes.

Is it Better to be an Active or Passive Real Estate Investor?

At the end of the day, only you can answer this question. If you enjoy being hands-on, dealing with tenants and being able to keep a direct eye on your investment portfolio, being an active investor in real estate could be perfect for you. You’ll certainly meet a lot of interesting people and gain some excellent experience.

If you have the time to devote to managing your investments, a knowledge of how to do it, or a willingness to acquire this knowledge, being an active investor may suit you. Many active investors gain so much experience managing their own assets that they go on to start property management companies, which ironically, generate passive income for them. Real estate is a popular choice for generating passive income.

On the other hand, if you prefer to earn income from real estate investing without having to be hands-on, making passive investments through crowdfunding, REITs and mutual funds will be right up your alley.

Should I Invest in Passive Real Estate Offerings or Stocks and Bonds?

Over the long haul, the stock market has performed well and generated lots of wealth for passive investors, and the same thing can be said about real estate. Determining whether the stock market or passive real estate investing is better for you depends on a lot of variables.

First among those variables is your risk tolerance. How much volatility and investment risk can you stand? Stocks can multiply in value exponentially overnight, but they can also fall that quickly. And you usually have to sell your stock to get the money out of it, although some stocks pay dividends. Real estate can be another viable investment option, offering passive income through renting and potential tax advantages.

Passive real estate investing, on the other hand, allows you to keep your assets and earn money while it appreciates. The disadvantage of passive real estate investing is usually the cost factor. Acquiring real estate is an expensive affair, which is why crowdfunding and REITs came about in the first place.

Additionally, it can be much easier to liquidate stock shares than real estate assets. You can sell a stock in minutes. Selling a single-family home or apartment complex can take several months, even if it’s a desirable asset. Most crowdfunded real estate investments, REITs or mutual funds have hold periods during which you can’t sell, even if you really need access to your capital.

At the end of the day, the best answer to what’s a better passive investment between real estate and stocks is to take the middle road. Build a diversified portfolio with a nice mix of real estate assets and securities. Talk to a reputable investment advisor about your goals and formulate a solid passive investment strategy so you have the best of both worlds.

Best Passive Real Estate Investing Platforms

Diversifying Your Portfolio Passively

Being able to generate passive income is one of the most important progress markers on the road to economic independence. When you’re earning passive income, your money is making money for you every day even if you’re unable to work. That’s why generating passive income through real estate should be the ultimate goal for every investor, which many REITs have a track record of doing. Adding them to your investment accounts, allowing for normal market increases which can produce quality market returns and adding more of them to your investment fund is often the way to go.

The good news is that there are more ways than ever for you to generate passive income through real estate investing. All you have to do is put your mind to it and start doing your research. If you conduct your due diligence and find something you like, take the plunge and hope for the best. In the meantime, you can count on Benzinga as a resource.

Frequently Asked Questions

Q

Can I make money in real estate investing?

A

Many people make a lot of money by investing in real estate. The key is to buy the properties well and manage them to prevent any issues.

Q

Can I add to my homestead for a rental?

A

Yes, you can add an Auxillary Dwelling Unit (ADU) to your home and rent it out.

Q

How many rentals do I need to be a full-time landlord?

A

The number of rentals you need to be a full-time landlord depends on what your income requirements are. Figure out how much you need to earn and use that for your calculations.

Accelerate Your Wealth

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