Passive real estate investing allows investors in a real estate project to be detached from the day-to-day property management while still receiving cash flow from the property’s rental activity and/or capitalizing on the appreciation when sold.
Once the investors fund the real estate project, the managers will provide their expertise and execute the investing business plan. By working with a sponsor, passive investors do not need to be involved with purchasing the property, maintaining it, or actively managing their properties. Investors just need to fund the property, then receive monthly or quarterly dividends throughout the time of real estate activity. Read further to gain knowledge to become a top passive real estate investor.
Active Real Estate vs. Passive Real Estate Investments
Active real estate investing requires some amount of hands-on work in contrast to passive investments. This type of investment may appeal to investors who want to get involved in real estate and have the time to dedicate to being a full-time landlord. Active investors purchase a rental property, oversee its daily operations and perform management duties
Passive real estate investing is after the investors select where to put their money. Individual investors contribute capital to the real estate project and then count on the sponsors to deliver dividends. The investment sponsor takes on the role of the active investor, including managing the investment with little contact with the shareholders.
Types of Passive Real Estate Investments
Passive real estate investing encompasses many different types of investing strategies including real estate crowdfunding, outsourcing a property manager, real estate investment trusts (REIT), real estate investors clubs, and real estate private funds. There are several ways that both accredited and non-accredited investors alike can begin to generate passive income to diversify their portfolios. Below are types of passive investments.
Real Estate Crowdfunding Investments | Fractional Real Estate Investing
Real Estate Crowdfunding is passive investing through regulation CF or Regulation A SEC filings. These two SEC regulations allow non-accredited investors to invest in assets that they used to not be able to. Prior to those regulations going into effect, only accredited investors could invest. This works by the investor buying equity shares in a rental asset, whether long-term or short-term rentals, from an investment company that then manages the investment properties and sends quarterly dividends to the equity shareholders. The investment company, like Yieldstreet or Fundrise, handles all management including dealing with the tenant’s rent, maintenance, and property costs.
Outsourced Property Manager
This type of passive real estate investing is when an investor either has a property or buys a property and then hires a property manager to handle the tenant’s rent and property maintenance. The investors can choose the property themselves or even outsource that to a property-sourcing company for a cost. This is a great choice for an investor who has the wealth to pay for an investment property themselves or get a mortgage, therefore not having to pay additional fees outside of the property management fee. An investor also has more control over the portfolio asset compared to the crowdfunding investment method.
REIT Investor | Mutual Funds
Public or Private REITs funds are great options for investors looking for a slightly more off-hand approach to real estate investing. A REIT allows individuals to invest in large-scale, income-producing real estate portfolios. A REIT is a company that owns and typically operates income-producing real estate or related assets like commercial properties, shopping malls, apartment buildings, hotels, resorts, self-storage facilities, warehouses, and mortgages or loans. However, a REIT does not develop real estate properties to flip, they are a buy-and-hold operation as part of its own investment portfolio. You can buy mutual fund REITs, private REITs, or exchange-traded funds.
Real Estate Private Funds
A private fund property portfolio is offered under Regulation D SEC offers. It’s typically considered the wild wild west as there are very lax regulations for these, making them a risk. Therefore the SEC only allows these investments for accredited investors, so make sure to do your due diligence on the investment’s company history and strategy. You can see the requirements for being considered an accredited investor on the SEC website. Many believe that these offer higher rates of returns due to how these investment companies advertise a high internal rate of return, sometimes in the 20+ percent. However, IRR is a very easily manipulated rate of the return number. The internal rate of return is reliant on the timing of cash flows, so the shifting of cash inflows or shortening the period they occur can change the IRR massively.
Real Estate Investing Clubs
Investment clubs were very popular before the proliferation of the internet due to the struggle it was to get accurate information. Mainly investment clubs were built around buying and selling stocks but investment clubs can be for any asset class. Real estate investing clubs have grown in popularity over the recent years allowing people who want to invest in the same type of asset to pool their money together and buy a bigger property asset than they normally could. In the digital age, real estate investment clubs can include people outside your sphere of influence which expands the reach and potential. One great platform to manage these investment groups is Tribevest. Real estate investment clubs aren’t as passive as private funds or fractional ownership but they also don’t come with heavy management and asset fees.
Risks and Rewards of Passive Investing
Like any investment, passive real estate investing comes with risks and rewards. One of the biggest risks is that real estate is a relatively illiquid asset compared to stocks or bonds. This means that it may be difficult to sell your investment quickly in the event of a financial emergency. Additionally, real estate investments can be affected by changes in the local real estate market, as well as changes in the broader economy.
On the other hand, passive real estate investing can provide a number of benefits, including the potential for steady rental income and capital gains from property appreciation. In addition, real estate is often considered a stable asset class and can provide diversification for an investment portfolio.
Real Estate Investing Definitions
Capitalization Rate (CAP)
The capitalization rate is the return rate based on the property’s expected income. The cap rate is calculated by dividing the net operating income by the market value of a property.
Cap Rates = NOI/Current Market Value
A cash dividend is a distribution paid to equity shareholders as part of the investment company’s current earnings or accumulated profits in the form of a cash payment.
Cash flow refers to the net amount of cash and/or cash equivalents coming in and out of an investment company’s bookkeeping.
Internal Rate of Return (IRR)
Internal Rate of Return is used in financial analysis to estimate the profitability of a potential investment. Can be highly manipulated.
Securities are defined by the SEC as any note, stock, treasury stock, security future, security-based swap, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a ‘‘security’’, or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.
Passive Real Estate Conclusions
In conclusion, passive real estate investing is a great way for many investors to earn a passive income and potentially grow their wealth over time. Whether through REITs, ETFs, crowdfunding, or other investment vehicles, there are many options available for investors looking to invest in real estate. However, as with any investment, it is important to understand the risks and rewards before making a decision. Passive investing is great for busy professionals or individuals without the financial means to purchase realty on their own. Consult with a financial advisor and research various investment options to determine the best passive real estate investment strategy for your financial goals and risk tolerance.
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