Active vs Passive Real Estate Investing

Real estate investing can be categorized into passive and active investing – similarly to equities investing. There are multiple ways to get started in either category. For most people getting into real estate investing, we recommend starting with passive investing and then deciding whether active is also right for you.

Passive Real Estate Investing

Before the days of the internet, real estate investing was a very hands-on industry. To reap the benefits of investing in property, you would usually need to be involved with the daily inconveniences of managing that property. It’s not like investing in stocks where you simply sit on shares in a brokerage account. Real estate investing used to require boots on the ground unless you had the money to pay for professional management.

Now investors can get their hands in the cookie jar through a number of different avenues. Real estate investment trusts (REITs) have long been available to investors through market exchanges, but with brokers dropping commissions, these types of real estate stocks are more accessible than ever.

Passive real estate investing has also evolved into a crowdfunding movement where investors bypass the brokers and REITs to actually stake ownership claims on individual properties. Companies like DiversyFund, CrowdStreet and RoofStock allow investors to get in on the ground floor of real estate investing and benefit from both property appreciation and rental cash flows.

Active Real Estate Investing

Active real estate investing is the path to higher profits, but you’ll need to get your hands dirty to be successful. You’ll also likely need a larger amount of capital to get started.

Active real estate investors locate land or properties themselves and do all the legwork required to obtain financing. Then they either manage the property themselves or outsource the work to a professional management team.

Active real estate investing is riskier than passive real estate investing. A building is expensive to maintain and quality renters can be difficult to find.

If you choose to manage the property yourself, you need to be ready to perform daily maintenance, collect rent, find new tenants to replace outgoing ones, pay taxes and handle complaints between residents. Managing a property is a full-time job, which is why many owners choose to part with some of their profits by hiring a building manager.

Active real estate investing usually falls into 1 of 2 camps:

• Managing rental properties
• Flipping houses

Rental properties can be leased out to either commercial or residential tenants. One of the benefits of active real estate investing is the amount of authority you have in the decision-making process. You select the properties, negotiate the loan terms, choose your tenants and manage as you see fit. Rent prices and amenities aren’t decided upon by outside forces but by you as the property owner.

Flipping houses is a bit different but still requires a lot of hands-on work. The term “flipping houses” doesn’t just mean single-family homes, but any type of residential living space.

House flippers take beaten-down properties, fix them up as quickly as possible and sell them to new owners. House flipping can be a lucrative venture but the capital required for renovation can be a lofty sum and setbacks are common. Plus, you’ll still need to find a buyer once your hard renovation work is complete.

Ways to Start Investing in Real Estate

Buying a rental property

Buying an investment property is the basic approach toward real estate investing, with renting being an obvious method to bring cash in. The landlord receives rent from the tenant to receive cash flow after covering the costs associated with owning a property. These costs include mortgage payment, taxes, and maintenance. The rent is often fixed to accommodate a premium over the costs to the owner of the property.

Pros of Buying and Managing Properties

Owning your own real estate where you can control rent could be more lucrative than simply investing in an REIT or crowdfunding platform. In this scenario you are in control of your own situation and can stand to make substantial money. Property owners also have numerous tax deductions they can work with to reduce their tax bill when tax season comes along.

Cons of Buying and Managing Properties

While this type of real estate investing can yield huge returns, it can also yield huge losses if you are not familiar with what you are doing. You will want to put a lot of effort into researching the property you want to buy, but also the neighborhood it’s in. You want to make sure you are buying a property that will appreciate in value and in a place people want to live.

This form of real estate investing also comes with a lot of necessary effort. If people are going to be living or businesses are going to be operating out of your building, you will need to maintain the property. Doing this yourself, depending on the size of the business, can be quite an arduous task. You may need to hire a property manager, which can be another large expense.

REITs

The method with the lowest barrier of entry for real estate investing are REITs or Real Estate Investment Trusts. REITs are companies that make investments in income producing residential or commercial buildings. The REIT takes investors money and uses it to either buy new properties or make improvements on existing properties in their portfolios. Investors are usually paid back in the form of dividends from profits generated by the properties.

Pros of REITs

We like REITs because they take much of the difficulty out of real estate investing. Investors often enjoy the idea of real estate investing because it can be quite lucrative, but often underestimate the difficulty of researching properties, the process of acquiring those properties and finally maintaining those properties so they may generate revenue.

Investing in a REIT takes out that difficulty and simply allows investors to reap the benefits of a property.

Another positive about REITs is that they tend to have a higher historical return than traditional equities. According to DiversyFund, S&P 500 (a broad index of some of the biggest stocks in the world) has a 20-year average return of 8.6% while the 20-year average annual return for REITs are about 11.8%.

Finally, REITs are also great because they have a low barrier of entry, often just needed a few hundred dollars to be able to start investing. For traditional real estate investing, you often need at least $25,000 to start.

Cons of REITs

REITs are not without drawbacks however. The most obvious drawback being you don’t have much control over what the REIT is doing with your money. Investing in an REIT is just like investing in a stock in that you are entrusting that business to carry out actions that will maximize your return.

A REIT can be well managed or poorly managed, the same as any corporation. Another noteworthy thing about REITs is that by law, they are allowed to invest upwards of 25% of their assets in non-real estate ventures as well. If you are keen on being able to have greater control over the properties being invested in, a REIT may not be what you are looking for.

Real Estate Crowdfunding

A trend that has gained popularity in the past several years is real estate crowdfunding. The passive benefits of Crowdfunding real estate investments are highly similar to that of REITs. Both allow investors to direct money toward real estate properties and reap the returns without needing to actively manage the property.

The key difference is with crowdfunding you are directly investing in tangible real estate assets unlike with REITs where you are investing money with the company who in turn goes and invests money in real estate.