Active vs. Passive Real Estate Investing

Many budding real estate investors start by buying single-family homes or small (2-4 unit) properties because it is an attainable goal. Most people already have experience buying a home and it is a natural progression to buy a small property as the first investment. Countless investors have built large and successful real estate portfolios using this approach. However, it is a long and challenging path. It takes a lot of education, time, work, and capital to be successful as an active investor. 

Consider the Following Example:

If you save $10K/year and a 4-plex costs $200K, it will take you 5 years to save 25% for the downpayment for that first 4-plex. At a 10% return on your $50K investment, you will make $5,000 per year. At that rate, it will take many years to replace your income. 

Given that slow growth rate and the invariable challenges that come with owning smaller properties, many beginning investors give up early on in their investment careers and go back to their day jobs and abandon their dream of financial freedom.

We started investing using a similar approach, buying a couple of 4-unit properties and then scaling to 11-units, 16-units, 38-units, etc. However, this was a difficult and time-consuming journey. After a couple of years of learning the business from the ground up, we realized that we had to grow bigger or join the ranks of mom-and-pop real investors that work in the business and not on the business. 

The Syndication Path
As we were searching for other ways to grow in the business we discovered real estate syndications (if you want to know what a syndication is, download my free ebook) and the value of a team.
We also realized that most people are more interested in the benefits provided by real estate rather than actually owning the real estate themselves. 

So what are the benefits that investors are looking for?

Personally I look for 4 things from my real estate investments:

  1. Monthly Cashflow
  2. Equity Growth
  3. Favorable Tax Treatments 
  4. Improving the Neighborhood that I Invest In

As a passive investor, you can participate in all of these benefits without having to do any of the work. If you have a successful career and prefer to leave the property investing to a professional, then it may make sense to consider passive investing. You still get all the benefits of investing in large commercial real estate without the challenges associated with operating the investment. Of course, you share a portion of the profits with the syndicator. But larger deals typically have better returns than smaller deals, so your earnings on syndications may be similar to investing actively.
For example, we typically do deals that have a 2x equity multiplier over 5-7 years. That means your initial investment doubles every 5-7 years through a combination of cash-flow and equity growth.
So, for that same $50K example from before, you may earn 8%/year in cash flow. That is $4,000 per year. After 5 years, your $50K has now grown to $100K and you will earn $8,000/ year; after another 5 years, it is $16,000/year. If this pattern of doubling every 5 years continues, you will be making a lot of money after just 15-20 years of investing (this assumes all money is reinvested and does not account for taxes).

Which Path IS Right For You

The path that you take is really a matter of your personal investment philosophy. If you are looking to start a new career and dedicate your energy into learning everything you can about property investing, the active path may be right for you. To get started, I always recommend that people listen to podcasts and read as many books as they can on the topic. I also strongly believe that everyone should hire an experienced coach or join an educational program. This serves two purposes. The first is to get the education that you need to be successful, the second is to connect with other people that are already successful as active investors.
As Tony Robinson would say: Success Leaves Clues.
Another key benefit of joining a group or working with a coach is having the support of accountability. We quite often set goals for ourselves, but without anyone holding us accountable, it is easy to not take action and relapse into our old habits. 

But, that is just the start. Education without action is just entertainment. The education needs to be put to use through effective action. You need to connect with brokers, lenders, property managers, and other key team members to find deals and actually make offers. In today’s competitive market it is difficult to find deals that make sense. So it requires a lot of discipline and work to locate a deal that meets the desired return criteria.
If you are willing and committed to this path, active investing may be the right path for you.

Focus Is Required

An active role in real estate investing is a second job and should be done with focus and dedication. If the active role seems too involved and you are just looking to diversify your portfolio, the passive role may be more appropriate. Of course, that does not mean you can completely hand over the responsibility for your investment due diligence to someone else. Even a passive investor must spend time understanding the market, asset classes, operators, and the potential deal that you are considering. It is your responsibility to be a good steward of your money and make wise investment choices. In most cases, the interest of the deal sponsor is aligned with the investor, but just make sure that you understand how the deal is structured and how everyone involved is  compensated.
Ideally, you want to find a sponsor that has experience in the business, has a long-term view of the business, and has relationships with his or her investors.
Once you find the right sponsor you now have a relationship that can make you a lot of money in the long run and ensure that your financial future is well secured. I have had the best luck connecting directly with sponsors instead of going through crowdfunding platforms. I value the personal relationship with the operators, as I can follow how they operate their businesses and learn from them. The best way to find operators is by going to events, attending meetups, and listening to podcasts. Just be sure to carefully vet the operator before investing with them.

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Top Ten Tips For A Passive Real Estate Investor

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