When you think of “real estate investing,” what options jump immediately to mind?
If you’re like most people, you probably thought of flipping houses and rental properties first. But those investing strategies represent the tip of the iceberg. In fact, most real estate investing strategies are far easier, if less understood.
I’ve owned dozens of properties directly, and a fractional interest in thousands of units passively. And that says nothing of the loans and notes I’ve invested in.
So what’s the best way to invest in real estate?
It depends — on your goals, on your priorities, and most of all, on how important control is to you. Know your options and their pros and cons before you start investing, so you don’t suffer buyer’s remorse later.
Active vs. Passive Real Estate Investing
Active real estate investing involves buying properties yourself: think flipping houses or becoming a landlord. You (or your LLC) becomes the owner on record, you have to go out and find the deal, you find financing, you come up with a down payment, you hire contractors and oversee renovations, you manage tenants or property managers, and so on.
Passive real estate investing involves investing money without taking any responsibility for asset management or property management. You don’t take on any of the headaches of owning a property by yourself.
There are countless ways to invest actively or passively. A few options for active real estate investing include:
- Buying long-term rental properties
- Buying short-term vacation rentals and running a hospitality business
- Flipping houses
- Flipping land
- Buying and operating mobile home parks
- Buying and operating self-storage facilities
A few options for passive real estate investing include:
- Lending money toward secured loans (such as Groundfloor’s LROs)
- Lending notes to real estate investors or real estate businesses (such as Groundfloor’s Notes)
- Buying fractional ownership in residential properties (whether long-term or short-term rentals)
- Buying fractional ownership in multifamily, self-storage, mobile home parks, or other commercially-zoned properties
- Investing in pooled funds that own properties or secured real estate debts
Technically, real estate investment trusts (REITs) also count as passive real estate investments. And while they can pay dividends over 10% at times, they come with their own unique pros and cons beyond our scope here.
Pros & Cons of Passive Real Estate Investing
Passive real estate investments come with their own upsides and drawbacks. Get comfortable with them for an infinitely scalable way to invest in real estate.
Advantages
Below are the reasons I currently invest passively in real estate.
- Options to invest small amounts: Sure, if you go out and invest in a real estate syndication or private equity fund by yourself, you’ll still need to pony up $50-100K. But you can split those high minimums through group real estate investing, or invest a few dollars at a time through real estate crowdfunding. Groundfloor lets you invest $10 in LROs, for example.
- No labor required: The name says it all — when you invest passively, you just contribute money, not time or effort. Someone else takes on all the headaches.
- Ease: no skill necessary: You don’t need to know how to find deals or manage contractors or pull renovation permits. You just transfer funds and sit back to collect cash flow.
- Short-term investments available: There aren’t many short-term investments in real estate, but you can find a few among crowdfunding platforms. Like, say, Groundfloor!
- No accounting headaches: When you invest in crowdfunding platforms that pay interest or dividends, you get a 1099 form at the end of the year, just like stock investments. When you invest in real estate syndications, you get a K1 form. Either way, you just plug the bottom line number into your tax return.
- Accelerated depreciation: Real estate syndications usually conduct a cost segregation study, which helps owners (including fractional owners like you) deduct more for depreciation in the first few years of ownership. The upshot: You get to show a loss on your taxes, even as you collect cash flow in real life.
Downsides
There’s no such thing as a perfect investment. And if there were, everyone would flood into it and ruin the returns.
Keep these disadvantages in mind as you explore passive real estate investments.
- No control: When you invest passively, you’re not in the driver’s seat. The asset manager decides how to fund investments, when and whether to refinance properties, when to sell or hold. You don’t take on any of the headaches of managing a property, but you also don’t get any say in it.
- Low liquidity: Most passive real estate investments don’t offer many options to withdraw funds early, if they offer it at all. You could end up stuck holding an investment for five years or longer, with no way to pull out your cash.
- Restricted options for non-accredited investors: Some passive real estate investments only allow accredited investors to participate. That goes for some crowdfunding platforms as well as some real estate syndications, although non-accredited investors still have plenty of options. For example, Groundfloor allows non-accredited investors to participate in LROs, notes, and cash advances, and SparkRental’s Co-Investing Club only reviews group investments that allow everyone to participate.
Pros & Cons of Active Real Estate Investing
Before you decide whether to take on the responsibilities of owning a property directly, make sure you understand both the pros and cons.
Advantages
Plenty of investors swear by their individual investing strategy. Beyond the pros and cons inherent in all real estate investments, active investing comes with a few specific advantages:
- Asset control: You choose exactly when and what to buy, and when and how to sell. That could mean a quick flip or holding the property for life. You decide how to update or modify the property, if at all. And who to rent it to (within the confines of Fair Housing laws) or who to hire to manage the property for you.
- Financing control: You take out as much or as little debt as you like, choosing the lender and loan type. Advanced investors can combine lines of credit, credit cards, seller financing, or other creative financing options. You could even potentially pull your entire down payment back out of the property within a few months of buying, using the BRRRR strategy of real estate investing.
- Offset up to $25K in active income: As a landlord, you can potentially use passive losses to offset up to $25,000 in active income from your job or business. Read more on rental property passive losses for full details.
Downsides
Control comes at a cost, and in this case, many costs.
- High minimum investments: Sure, you could flip plots of land for $5K apiece, but that’s the exception rather than the rule. In most cases, you can expect a minimum 20% down payment on a property costing hundreds of thousands. And that says nothing of closing costs. A typical investment property requires $50-100K in total cash invested.
- High labor requirements: It takes a lot of work to find bargain deals on properties, arrange financing, repair them, maintain them, advertise them, screen tenants, collect rents, enforce your lease, and so on.
- Difficulty: high skill requirements: All of those tasks listed above each come with their own skill set. For example, finding good deals on properties isn’t as simple as browsing the MLS. Most investors choose a niche such as buying pre-foreclosures, or buying properties through probate, or massive direct mail campaigns to owners of abandoned properties. And each niche strategy requires mastery. Multiply that by every task and you need an entire education around real estate investing.
- Long-term investing: Real estate is an inherently illiquid investment — it’s expensive and time consuming to buy or sell. That makes it a long-term investment unless you flip houses.
- Accounting headaches: When you own properties directly, you’re responsible for tracking every expense and every cent of income. And then you have to report on them accurately, on a completely separate schedule of your tax return. Make a mistake and the IRS comes knocking with fines, penalties, and even the risk of jail time.
Bottom Line
Today, I only invest passively in real estate.
Why? Because I value my time more than I value control. I spend most of the year overseas with my wife and daughter, all while running a business. I don’t have time to chase down tenants for rent or hassle with permit inspectors who fail every property the first time, just to prove to their supervisor that they hit every property on their rounds. Someone else can take on those headaches for me.
Besides, I’d rather invest small amounts in many passive investments than invest huge sums in a few properties. I can’t predict the market, but as a passive investor I can put small amounts in hundreds of investments all across the country. Those include debt investments like Groundfloor notes and LROs, and also equity investments like real estate syndications. It also includes property types ranging from multifamily to mobile home parks, single-family rentals to self-storage facilities and beyond.
A few will lose me money. A few will earn enormous returns. Most will perform in the middle of the bell curve — and that’s fine with me, when I’m targeting 10-30% returns.
About the Author
G. Brian Davis is a real estate investor and cofounder of SparkRental who spends 10 months of the year in South America. His mission: is to help 5,000 people reach financial independence with passive income from real estate.