Is it better to be a passive or active real estate investor?
As a real estate investor, you can invest passively or actively. A passive real estate investment is an investment that requires little to no day to day decisions from the partner. The asset is usually managed by another partner, known as a managing partner or operator/sponsor. Conversely, active investment is one that requires some input or work from the partner to properly manage the property. Some of this work includes working with sub-contractors, managing renovations, managing tenants, collecting rent, repairs, bookkeeping, etc. If you are required to make any decisions regarding the wellbeing of the property, you are considered an active investor. Some people consider being a landlord a passive investment; unless you have systems in place and a qualified property manager handling your asset, getting a call from your tenant about a broken toilet at 10 pm on a Friday is anything but passive. This article will go over the benefits of each depending on your situation.
Passive Investments
As a passive investor, you are considered a capital investor or limited partner, usually putting up money to fund the deal. Because you are not required to make decisions on the operation, this gives you the time flexibility to do other things and not have to worry about the asset. This type of investment is great for those who do not have much time to manage a property or tenants and would much rather spend their time earning money elsewhere or spend time doing other more important things. Of course, this type of investment is only worth making if you work with an operator partner who you can trust to run the property well.
Multi-family apartment building is an example where having a best in class operator partner is crucial. A good operator can execute and manage the asset based on a sound plan and make the asset much more valuable. That’s the difference between gaining millions and losing money.
Simple asset class such as single-family properties, there’s no need for best in the class operator because these properties are limited to what it can be done to increase value. Complicated assets like apartment building are like traditional businesses, and good managers, systems and relationships are necessary for the asset the thrive. The more complicated the deal is, the more value the operator can add.
Because these investments required no time from the passive investor and without the need to be an expert on the market or asset itself, this allows the investor to invest in multiple assets across different geographies, property types, tenant types, management types, and operators to stay diversified. An active investor would have a harder time investing in multiple assets across the country if they want to manage each asset well.
Active Investments
Although passive investments have their benefit, it’s not for everyone; While being passive is great for some people, the lack of control over decisions of an asset is a drawback for others. Passive investments rely on the expertise of operators to make the right calls for the asset. If you are someone who likes to manage assets yourself and make decisions, being an active investor may be the way to go.
As an active investor, you will also incur credit and liability risks for the investment properties you purchase and manage. Most banks will require personal guarantees on the properties you borrow on, and because these assets usually involve other people, (tenants, contractors, etc) there are liabilities to consider. Make sure the asset carries the correct and right amount of insurance to minimize risks. On the other hand, limited partners (passive investors) do not incur credit and liability risks due to the distention of classes of shares between the general partner, operating partner/sponsor and limited partners.
Unlike stocks, real estate investments, especially apartment buildings, are generally considered illiquid assets due to the time required by the buyers to do their due diligence and the nature of the asset. However, you can sell quickly if you offer the asset at a deep discount or fire sale. Active investors can choose to sell the asset to capture any equity on the asset at any time if their situation calls for it, even if the time is not right to sell. On the other hand, operators and general partners of an investment do not base their decisions of individual investors to do what’s right for the asset (most sponsors of investment do offer limited partners a way to sell their shares in case of an emergency).
Conclusion
If you are active in the real estate, have the network and know-how, as well as the time and systems to manage these assets, you may wish to take on these investments yourself. Active investing are for those who like to be hands-on and rely on their expertise. If you value your time and rather spend it with your family or your job, passive investments may be right for you.