Active vs Passive - Which Investing Strategy is Right for You?
As an individual investor looking to invest in real estate for a steady income stream, is it better to be an active or passive investor?
Short answer, it depends. It depends on your investing goals first and foremost, but also depends on your level of expertise, time commitment, and ultimately the risk you are willing to take. As investors we all want the benefits of real estate investing, but are you committed to the headaches of being a landlord in hopes of possibly generating higher returns?
Let’s dive in and discuss.
First, we’ll need to define what an Active and Passive investing strategy is:
Active investing can involve a thousand different real estate investing strategies, but for our purposes we’re defining it as an investor that purchases a Single-Family Rental (SFR) or small Multi-Family (MF) for cash flow. Active investors are involved in every aspect of the deal from finding the property, conducting due diligence, obtaining financing and personally guaranteeing the loan, and ultimately managing the property or hiring a third-party property manager (cost is typically 8-10% of rents for small properties).
Passive investing is what we focus on here at Bonne Capital, and it provides investors more of a hands-off approach. Investors place their capital into a real estate syndication that is managed by an experienced operating sponsor/partner. With this approach, you are outsourcing most of the work required to successfully purchase a deal to a sponsor. You should still vet the sponsor and make sure it’s someone you trust and has a proven track record, but for the most part this is a hands-off investing strategy.
I’ve been on both sides and can discuss the benefits and risks of each. In my opinion, it comes down to 3 major criteria: control, time commitment, and risk.
As an active investor, you are 100% in control. You control the business plan and decide which investment strategy is the best fit for you. You will choose the rental rate, decide on the renovations needed, screen tenants and decide on the criteria to qualify a tenant, and ultimately be the one who decides whether to sell or refinance at some point in the future.
As a passive investor, you are a limited partner in the deal. Once you’ve vetted the operator and the deal, you simply provide your capital to an experienced sponsor/operator who will use those funds to manage the entire project. You have no control once you invest, therefore you need to understand you’re putting a lot of trust into the operator and their team to execute the business plan presented.
Are you willing to do all the work upfront and on an ongoing basis to have complete control? That’s something only you can decide.
2) Time Commitment
To get the best returns in real estate, or any investment for that matter, the goal is to buy low and sell high. Whether you’re active or passive, most real estate deals require improvements to the asset as well as the operations/management of that asset. It is a time-consuming task to maintain the property, find tenants, schedule showings, collect rents, and handle any maintenance issues that arise.
As an active investor, you do have more control, but that control requires more time. You’ll spend time educating yourself on how to invest in small SFR or MF properties, how to manage them successfully, how to deal with tenants, etc. If you do decide to hire 3rd party property management, you’ll have to vet them and could ultimately end up managing them as well (that’s from personal experience!). While 3rd party property management could take the ongoing workload off your plate, you will have to make big decisions when something unexpected occurs which will come with unwanted stress and additional headaches.
On the flip side, passive investing takes up very little of your time. You don’t have to worry about anything mentioned above, as your main job is to find a good deal with a good operator and be hands-off from there. You invest your money and stay in the loop via monthly/quarterly updates throughout the life of the investment.
Active investing is the riskier strategy, as you are typically buying small properties with recourse loans and personal guarantees. If the deal goes south, the lender is coming after not only the property, but your personal assets as well. You own 100% of the deal, therefore you get 100% of the profits, but also the losses. You may have a chance at higher profits given the higher risk, but that isn’t always the case. You may find you’ve blown through a renovation budget, you can’t find reliable contractors, or some unexpected issue pops up during renovation that you aren’t prepared for. This can wipe out your cash flow for at least a couple months, if not the entire year.
Another risk is diversification. As an active investor, the deals you are looking for are likely within an hour’s drive of your house, so you can easily get to them if needed. Depending on what market you live in, this could be a big disadvantage. Do you want all your eggs in one or a couple small baskets in one market?
When investing passively, you have significantly less risk. You should be investing with an operator who has a proven system and has successfully taken deals full cycle in the past. Ideally, they already have assets in the market you are investing in as well as strong relationships with property managers, vendors, etc. The returns are more certain as you’ll know what the projections are ahead of time. You can ask for the operator’s track record on how past deals have compared to their projected returns. Assuming you’ve found an operator who underwrites conservatively, the projected returns should be met or exceeded. If your goal is a steady and predictable income stream, passive investing is for you.
When passively investing in real estate syndications, you are only at risk for the money you put into the deal. A lender cannot come after the personal assets of the limited partners giving you peace of mind that your personal assets are protected.
Passive investors also enjoy the opportunity to invest small chunks of money in multiple deals, across multiple geographies, with multiple operators. Diversification is key in any investment portfolio, and passively investing in syndications is a great way to diversify your holdings.
As we’ve discussed, there are multiple ways to become a real estate investor. Every strategy is different, so it’s important to understand the pros and cons of each and identify which strategy best aligns with your goals.
If you find yourself with a lot of time, willing to take on more risk for the chance of higher returns, and have invested in your education, then an active strategy could work well for you. On the other hand, if you’re a busy professional, business owner, or simply tired of being a landlord, then passively investing with proven operators could be a better fit for you. It gives you the ability to diversify your portfolio, generate passive income, and requires very little effort on your part.
I’ve done both and am currently in the process of selling my personal portfolio to invest passively in real estate syndications. In my opinion, on paper the returns are often similar, however the risk transfer, level of effort, and reliability of an experienced operator make passive investing the smarter choice for most.