If you’ve entertained the idea of investing in real estate, chances are you have come across the concepts of active and passive real estate investing.
This article will examine both investment strategies and help clarify the main differences between active and passive real estate investing. By the end of this article, you’ll have a better idea of which investment strategy is right for you.
Active or Passive: The Level of Investor Involvement
The most obvious difference is apparent in each strategy’s name—active and passive. Though there is some risk in splitting all investors into two distinct camps, in general, the following distinctions between active and passive investors hold true.
Active Real Estate Investing
Active investment strategies have a high level of investor involvement. They not only front the investment capital, but they may sit on boards and make decisions regarding investments. Usually, active real estate investors are direct purchasers of the property, either in whole or in part.
Another way active real estate investors live up to their namesakes is through the amount of work they must do to be successful investors. Active real estate investors should be able to:
- conduct extensive property research
- possess a high degree of financial literacy
- understand risk management
- know how to draft leases and other legal contracts
- can project costs and returns into the future
- are familiar with niche-specific aspects of the real estate industry
As readers will notice, to be an active investor requires a lot of familiarity with the real estate industry as well as the ability to conduct financial analyses and draft related documents. Put another way, being an active investor is not merely a full-time job, but several!
Many of the entities that engage in active investing are, in fact, not individuals but rather teams of people who make up departments of entire real estate investment firms. And these residential and commercial real estate investment firms make up the bulk of companies that passive investors invest in.
This brings us to passive real estate investing.
Passive Real Estate Investing
Many people simply do not have the time to learn how to be active real estate investors. However, many people do have spare capital they’d like to invest.
Here is a simplified way of imagining what follows:
An Investment Parable:
Groups of active investors saw a need for their knowledge and expertise in a new, emerging market of wealthy, high-income earners who had an interest in investing in real estate but had no experience.
These high-earners who had the means but not necessarily the know-how to invest in commercial real estate could lend their capital to real estate investment firms, seeing annual returns and doing none of the work. They simply provided the capital.
This is the origin story of many real estate companies who, upon seeing this opportunity, pooled their interests to form investment trusts and private equity firms. It’s companies like these that allow passive real estate investors to see returns on their investments without having to do much of the work.
Options For Passive Investors:
The above parable was merely a simplified way of explaining the origin of real estate investment firms, which paved the way for passive investors to get in on the many niches of the real estate industry. In reality, passive investors in 2022 have many options for investing in real estate.
Here are some of the most proven options:
REITs and REIT ETFs
REIT stands for real estate investment trust. REITs are publicly-traded companies that investors can purchase and trade shares in on open markets. Investors see returns as they would for any other publicly traded stock. However, they have practically no say in the company’s investment decisions.
REIT ETFs are exchange-traded funds that buy shares in REITs. Passive investors who want to mitigate risks might choose to invest in REIT ETFs over a single REIT. REIT ETFs are even more diversified than individual REITs. This explanation can cause acronym overload, so let’s look at it in a different way:
Self Directed IRAs
A self-directed IRA (individual retirement account) opens numerous opportunities for savvy investors. One such opportunity is an investment in real estate. In the booming market, it provides excellent returns to passive investors while saving them from possible financial trouble.
Nevertheless, practicing due diligence is essential when investing in real estate. Therefore, you must learn about the safety and pitfalls of owning real estate in an ira and fund your assets accordingly. In such a situation, it would be wise to seek guidance from financial experts and learn about market conditions.
Understanding REIT ETFs
- A single owner who purchases one property takes on the most risk
- A single owner who purchases multiple properties diversifies that risk across those properties
- Numerous owners who purchase multiple properties together take on even less risk
That makes sense, so let’s extend this to companies.
- A single company that invests in several properties still has risk spread across those properties
- A company that instead invests in those companies that invest in multiple properties spreads that risk out even further.
ETFs are those companies that invest in several companies and are seen as the least risky.
Real Estate Private Equity Firms
Private equity firms are not publicly traded companies. Instead, they are privately traded, which means they are only open to accredited investors. Generally, there are steeper investment minimums to invest in private equity firms.
However, this option gives partners a direct stake in the company’s investment decisions and affords passive investors slightly more control than they’d have investing in REITs and REIT ETFs.
Crowdfunded Real Estate Investment Platforms
Tech platforms have disrupted many industries, including the real estate investing industry. Crowdfunded real estate investment platforms like Fundrise allow lower-net-worth investors to have a direct way to invest in residential and commercial real estate.
These platforms have the accessibility of a stock—some with investment minimums as low as $10—but allow for the potential for platform users to have direct access to the decision-making process regarding the development and management of real estate properties.
Which Investment Strategy Is Right For You?
Take a deep breath and take a moment to absorb everything! Getting into investing can feel overwhelming, but it’s definitely digestible bite by bite. To sum it all up:
- Being an active investor is a full-time job
- Being a passive investor is the way to go if your full-time job isn’t being an active investor
Roni Davis is a writer, real estate investor, and legal assistant operating out of the greater Philadelphia area.
Roni Davis is a writer, blogger, content strategist, and legal assistant operating out of the greater Philadelphia area. She writes for Todd Mosser, a criminal appeals attorney in Pittsburgh, PA.Edit