The Tradeoffs Between Active and Passive Real Estate Investing

It is no secret that real estate investing has the potential to create a lucrative and fulfilling path to financial independence. People from all backgrounds and life experiences get involved with real estate investing for various reasons and via different paths, from scouting their local market for wholesaling opportunities to managing large-scale commercial properties. 

If you are exploring real estate investment opportunities, specifically in the multifamily arena, you may have come across the concepts of active vs. passive investing. This blog offers a high-level look at the difference between the two, what you gain, and what you give up depending on which investment path you want to take. 

Spoiler alert: You can choose both! 

What is active real estate investing?

Active real estate investing comes in many forms, including landlording, house flipping, and managing apartment syndications. Short-term rental management, like operating Airbnbs, also falls under the active real estate investing umbrella. The common idea is that you’re involved in the project's day-to-day operations.

What you gain as an active real estate investor

Active real estate investing allows you complete control, from what you buy, to your business plan, who you hire, when you sell, and so on. With that comes the increased knowledge and experience gained through a hands-on approach. 

In addition to these benefits, active investors typically earn a higher return on investment. While there are still costs associated with active investments, depending on how you structure your business plan, you can avoid the need to pay property management or acquisition fees if you purchase and manage the property yourself. This gives you the opportunity to end up with more money in your pocket at the end of the day. If you limit the number of partners you’re working with, you’ll also have fewer people to split the profits with.

The time you invest as an active real estate investor will likely qualify you for real estate professional status, which comes with plenty of additional tax benefits. Check out our blog about what it takes to gain REP status according to the IRS and how it can benefit you. To qualify for REPS, you must spend 750 hours per year on real estate-related activities and spend 50% of your time in real estate. You’re likely to achieve this status relatively easily as a full-time active investor. Real estate professional status allows you to limit your tax exposure by offsetting your regular income with passive losses from your investments. 

At the end of the day, if you want to live and breathe real estate investing, this is likely the path you will choose and ultimately enjoy because you’re doing it every day.

What you give up as an active investor

Like most things in business, sacrifices are also required when there is something to gain. As the lead investor, you must become an expert in the market you want to invest in and the asset class you’re purchasing and managing. You can certainly learn as you go, but it’s important to spend time educating yourself upfront and learning from others who have paved the way. 

Depending on which type of property you’re buying and how you plan to acquire it, you may need to consider additional funds for a downpayment, renovations and supplies, contingency costs, and unexpected expenses. Without proper planning, any of these could affect the investment's liquidity. 

You’ll need to dedicate time to coming up with a business plan and analyzing the numbers before getting started. Good deals tend to go fast, so the ability to analyze deals quickly is necessary and requires time and practice. 

The investment’s success rests on your shoulders, which requires a great deal of time, energy, and effort. Managing a project on your own can easily become a full-time job. Typically you’re trading out your spare time to take on being an active investor. It is important to understand and be prepared for what you’re giving up before diving into a project.

What is passive real estate investing?

Multifamily syndications and REITs are two examples of passive real estate investment opportunities. Passive investors are strictly involved in a project from a financial standpoint and are not responsible for any heavy lifting. As a passive investor, you are able to build a real estate portfolio while continuing to go about your everyday life. You don’t need to become a market expert or find reputable contractors. You’re not responsible for overseeing the construction or hiring a project manager.

To become a passive investor, all you need to do is align yourself with a syndicator that shares common goals and that you can trust to see the project through to completion. You pay your share of the money and then sit back while you reap the rewards. Of course, it is important that you still spend time educating yourself on how to analyze good deals, understand market dynamics, and spot red flags throughout the investment process. 

What you gain as a passive investor

When you invest passively, you get to keep your time for everything you love and enjoy doing. Once you choose your investment team, analyze an opportunity, and send over your portion of the money, most of the work is done on your end. Then it’s time for the experts to do what they do best. Throughout the project, you get to learn from them as they navigate the ins and outs of a large-scale property such as a multifamily apartment building or mobile home park. Passive investment opportunities allow you to be in the mix without the whole project resting on you. 

Depending on the type of project you choose, passive investing may allow you to get your foot in the door at a lower dollar amount than what would be required when purchasing a property on your own. While you don’t get to decide when you get your principal investment back, you are often provided a clear expectation of timelines when you make your initial investment so that you can plan your finances accordingly. 

What you give up as a passive investor

When you decide to participate in a syndication passively, you give up the control you would have as an active investor. You don’t have the day-to-day responsibility of managing the project, which means you don’t get to make decisions about how renovations are done or how to market the property. You must rely on managers and experts to see the job through to completion and according to the business plan that was laid out when you invested. 

Since you aren’t completing the work on your own, some fees are usually associated with buying and operating the property, including property management, acquisition, and portfolio management fees. These expenses vary from project to project but do eat into your overall profits. 

While there are still some tax benefits associated with passive investing, it’s not as likely that you will be able to achieve real estate professional status as discussed above and offset your regular W-2 income with passive losses from your investments. However, when you invest in private syndications, you can still offset the passive income you make from any investment, including syndications, with passive losses from the investment. There are different tax benefits for different investment scenarios, so be sure to plan ahead and craft a strategy with your CPA. 

Conclusion

There are many paths available for aspiring real estate investors. How you choose to invest depends on your personal and financial goals, how much time you’d like to spend on day-to-day activities, and what you want your bigger picture to look like. Remember that you can always be an active investor in one project while investing passively in others. Both options expand your portfolio and offer great returns on investment.  

If you’re interested in learning more about how syndications may help you progress your financial goals, schedule a free consultation with the EZ FI U team.

You Might Also Like: