Passive real estate investing involves using your money to purchase part of a property. You share the risk (and potential) benefits with others just like you. Best of all, you’re not required to do anything to maintain or improve the property. In fact, you may never see it in person.
Passive real estate investment options include trusts, crowdfunding, investment funds, and syndications. We’ll explain how they work and help you understand which option might be right for you.
What’s the Difference Between Active & Passive Real Estate Investing?
In a traditional (active) real estate investment, you pick a property, buy it, and take responsibility for it. For example, if you purchase an apartment building, you must find tenants, deal with repairs, manage rental agreements, and otherwise be the point person for your tenants. If you don’t want an active role, you must pay someone to do that for you.
Passive real estate investing involves working with a third party (like a company or a group of investors) to purchase something collectively. Investors rarely deal with the properties in person.
In an active real estate investment, people typically purchase homes, apartment buildings, or other residential facilities.
Several different types of properties could be purchased in passive real estate investing programs, including the following:
Retail: Invest in places like shopping malls, grocery stores, and other commercial outfits.
Residential: Invest in apartment buildings and other forms of multi-family housing.
Healthcare: Invest in hospitals, clinics, and other medical facilities.
Office: Invest in high-rises, skyscrapers, and other office environments.
Mortgage: Invest in the mortgages that fund home purchases.
An active real estate investment comes with more responsibilities. Typically, you’re required to fill up the space with tenants and deal with any issues they might have. In return, you have full control and could potentially see more profits.
Passive real estate investments don’t require as much hands-on work, and you may not need as much money to get started. You may also not need as much experience, as the company you choose could guide your purchase. However, they can come with smaller financial benefits.
Understand Your Passive Real Estate Investing Options
Several different models of passive real estate investing exist, and they all have different risks and benefits. Here’s what you need to know about each one.
Real Estate Investment Trusts
A real estate investment trust (REIT) is a company that looks for investors who want to purchase properties together. The investors don’t buy properties individually or manage them, but they do earn money collectively from their investments.
Several types of REITs exist, including the following:
Equity: Companies own properties in several sectors, and they give investors access to similarly diversified portfolios.
mREITs (mortgage REITs) : Companies fund mortgages that homeowners and others might use to purchase their properties. Investors gain access to a piece of the profits of these loans.
PNLRs (public non-listed REITs) : Companies own a variety of different properties, and they give investors access. These companies aren’t listed on the stock exchange, and they don’t offer the same liquidity that their stock-listed counterparts do.
The advantages of REITs are their ease of investment. You don’t need to know anything about real estate or financing to get started. However, the potential financial benefits can vary by things outside of your control, such as the stock market.
Real Estate Crowdfunding
Imagine if you could gather several people together and pool your money to buy something you own collectively. Real estate crowdfunding makes this possible.
Several companies provide crowdfunding investment opportunities, including the following:
This method gives you wide access to properties, so you can spread your risk accordingly. You’re typically not required to plop all of your available funds into the same opportunity, and mixing and matching could help you diversify your portfolio.
Real Estate Investment Funds
A real estate investment fund (REIF) pools money from several investors. The money is used to buy things like real estate, stocks, or bonds. Choosing a product like this is another way to diversify, as your money could be going into items that are related to properties but may include other things.
Several types of real estate fund structures exist, including the following:
Closed-end: You invest in the fund, and you aren’t allowed to remove your money until a set time has passed. Typically, you’re not allowed to pop more money into the account either. You only make money if the asset provides dividends.
Successive fund: Sponsors create a portfolio of several other funds and manage them accordingly. You make money when the portfolio does.
Domestic real estate: Legal entities (such as an LLC) manage the funds on behalf of all participating investors.
REIFs are all structured differently and come with altered benefits. It’s crucial to read the fine print carefully and understand the potential benefits and risks.
Real Estate Syndications
A real estate syndication is a group of investors that pool their funds to invest in real estate. These groups hire a sponsor to look for investment opportunities and manage the properties purchased.
If you invest in a syndication, you own a share of the property that’s directly related to how much you’ve spent. The more you put in, the larger your potential dividends.
A method like this ensures you’re not required to manage a property, as you’ve hired someone else to do so. However, you are working within a tight-knit community of buyers who may disagree with you on key aspects of managing the property.
What Should You Think About Before Investing in Passive Real Estate?
If you’re interested in funding real estate but don’t want the bother of managing it, passive real estate could be a good option. However, there are many important factors to consider before you jump in.
For example, you must assess how much you have to invest. Some of the options we’ve described have a very small price tag, while others are more expensive. Similarly, some allow you to withdraw your money when you need it, and others lock you into a specified time frame. Consider circumstances in which you might need to access that money and the likelihood of those situations.
You must also research each potential partnership. Unlike active real estate investing, in which the purchase might just involve you and a bank, passive choices usually involve third parties. You must ensure these are reputable companies that won’t charge you too much to get started.
Considering the tax implications is important too. A short-term investment could be risky, as you may not be able to avoid the capital gains hit. However, a long-term strategy could come with complex tax paperwork you’ll need help to untangle.
What Can You Try Instead?
Passive real estate investing is right for some people, but it’s not right for everyone. If you’d like to investigate another path, contact us about a 1031 exchange. This method allows you to transfer your investment in one property to another very similar one. You can avoid the tax consequences of a sale with this method while diversifying your portfolio.
At 1031 Pros, we focus exclusively on these types of transactions. We’ve helped thousands of people just like you explore the risks and benefits of this choice and make the right decision for them. Contact us to get started.
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