Real estate is often regarded as an alternative asset class, as compared to stocks and bonds. Though it is unchartered territory for many, it’s starting to garner more mainstream attention thanks to a number of digital platforms designed to make real estate investing more accessible to the masses. Let’s take a closer look.
The key difference between active and passive real estate investing is based on the amount of continuing work involved to support the investment.
In active real estate investing, though you might get the most control and the best tax benefits with fewest layers of fees, it requires extensive knowledge and can be a hassle for the landlord—the active participant. While in passive real estate investing, there are no landlords. Instead, investors invest through syndications, online crowdfunding, individual real estate funds, and real estate investment trusts. Passive real estate investing requires the least experience and hassle while offering more diversification and liquidity.
Put simply, passive real estate investing is investing in real estate without substantial hands-on effort or active participation from the investor. There are primarily two methods of passive real estate investing—direct or indirect.
Direct passive real estate investing
When it comes to direct real estate investing, an investor will purchase a property or portion of a property that is then rented out. Often, real estate investors that purchase entire properties will hire what is known as a property management company to take care of the day to day maintenance and tasks such as collecting rent. Post-purchase of the property, hiring a property management company allows an investor to essentially be hands-off in the management of the property. Hence the term passive real estate investing.
Indirect passive real estate investing
On the other hand, indirect passive real estate investing is a process where individuals invest in a REIT (Real Estate Investment Trust) or a real estate related mutual fund. This form of real estate investing is considered passive because there is no day-to-day management needed and it’s considered indirect because it doesn’t involve a specific piece of real estate. Investors collect passive income as returns or dividends from funds.
Passive real estate investing is often regarded as a smart way to invest in real estate. There are some simple ways to make money out of passive real estate investing.
1. Investing in Real Estate Investment Trusts (REITs)
Real estate investment trusts are corporations, trusts, or associations that invest in income-producing real estate. REITs give investors the option of investing in real estate without the expense of purchasing and maintaining an actual property. REITs generally have wider diversification, lower risk factors, and potential appreciation so they may be potentially beneficial additions to an equity or fixed-income portfolio.
This may work well for those looking to be passive investors because REITs are traded like a stock and one of the other potential benefits is the lower investment cost—as low as $500 for the price of one unit of a share. A REIT must also meet the SEC requirement of distributing 90 percent of its taxable income as dividends to shareholders, who then have to pay income tax on the dividends earned. Though it is appealing to income-oriented investors, sometimes it leaves less money in the end for reinvestment.
Equity REIT: One of the most common forms of investment, equity REITs buy, own, and manage real estate properties that generate revenue. The potential benefit of equity REITs as a long-term investment is the passive income generated primarily from rents.
Mortgage REIT: These entities loan money for mortgages to real estate owners and operators. They purchase either existing mortgages or mortgage-backed securities. In this case, the revenue is generated mainly by the interest they earn on the mortgage loans. Mortgage REITs are sensitive to changes in interest rates as the dividends are based on the interest payments.
Hybrid REIT: These have a combination of both the equity and mortgage REITs in their portfolios. They earn money through a combination of rents and interest. They structure the portfolio to more property or more mortgage holdings depending on the investing focus as stated by the trust.
REITs are further categorized based on how the shares are bought and sold.
Publicly traded REITs: These are REITs whose shares are listed on a national securities exchange and regulated by the U.S. Securities and Exchange Commission (the “SEC”).
Public Non-traded REITs: These are also registered with the SEC but don’t trade on national securities exchanges and tend to be more stable because they are not subject to market fluctuations.
Private REITs: These are neither listed with the SEC nor are they traded on a national securities exchange. They raise equity from a select group of private investors.
2. Real Estate Funds:
Real estate funds are types of mutual funds that invest mainly in real estate. Many real estate funds invest in REITs. They also offer certain benefits that may appeal to passive investors. They offer greater diversification, which is intended to lead to reduced risk and a higher potential for returns. A major portion of a real estate fund is often invested in commercial properties such as apartment complexes, office, retail, and land.
Real estate crowdfunding refers to a group of investors that each contribute money to become part of a real estate deal. These investors have the opportunity to be a part of multi-million dollar ventures thanks to the multitude of investors that each contributes to the deal. Sometimes it also works to help a real estate investor who may have a lead for a lucrative deal but does not have the funds to invest in it. This is where crowdfunding comes in handy as other investors pool their resources and help the active real estate investor to complete a project and sell it, ideally at a high-profit margin.
Real estate crowdfunding is mostly managed or operated through online platforms where you can own property and earn profits with only a few clicks. Investors visit the online marketplace and browse through the opportunities that appeal to them. Once they select an investment that matches their requirements, their funds are pooled with other investors and the investment is closed. Investors then begin observing the performance of their investment and collect the passive income that may accrue from it.
4. Investing in a turnkey rental property:
Though this is a more active kind of passive real estate investing, investing in a turnkey rental property can be a wise way to have a potentially steady flow of money without much interference. In this scenario, the investor can be a silent partner to someone who is doing the legwork. In this case, one needs to put in some money to acquire the rental first.
Then, a management company comes in to take on the responsibility of finding and maintaining the rental property. The professionals oversee the management while the tenants pay off the mortgage and/or increase the equity of the property. The company also makes sure that the rental is never vacant and helps to find quality tenants who will take care of the property and pay rent on time. Note that without a management company in the picture, this can be a challenging task for an investor who does not know how to deal with rentals and tenants.
Once the ball starts rolling on a turnkey rental property and the income exceeds the expenses, the investor starts making a profit from the investment.
The trends in major real estate markets have shown real estate value to appreciate more over time as compared to stocks and bonds. Inflation and the rise in the cost of living lead to an increase in rent and, therefore, passive income from rents also rise with time. In addition, real estate tends to be less volatile and the ability of REITs to generate dividend income as well as capital appreciation makes them a potential alternative to stocks and bonds. There are also certain tax benefits related to real estate investors that stock investors may not have. Real estate investment trusts receive extra tax benefits since they avoid high corporate taxes by paying out most of their income as dividends. This makes it easier for investors to buy with an IRA or other retirement accounts that allow for tax-advantaged investing.
Is passive real estate investing worth it?
Passive real estate investing can be one strategy to have a constant cash flow (either monthly, quarterly, or annually) without much active participation on your part. You can appoint trusted individuals with deep knowledge of the real estate world to put your money to work.
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