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When you think of a real estate investor, you perhaps picture someone who owns rental homes and manages their rental portfolio, finds tenants, hires vendors for repairs or rehab projects, and collects rent. This is an example of an active real estate investor. Passive real estate investing, however, does not require day-to-day involvement in the operations of a real estate asset. As a passive real estate investor, your role is to contribute funds to the investment, usually offered by a real estate group or syndication firm, while refraining from maintenance of that asset and its route toward profitability.
Passive investing does not mean that you are relieved of all responsibility. It’s vital to remember that when you invest passively, you must still do your research!
Benefits of passive investing in real estate
Passive investing requires a lower time commitment. Between family obligations, hobbies, and a full-time career, actively investing in real estate is not realistic for most individuals. When you’re an active real estate investor, it can be difficult to find the right deal, arrange financing, and put up with the hassles of the day-to-day management of a property. Passive investors reap the benefits of somebody putting that in place for them, and when a toilet breaks in the middle of the night or a unit needs maintenance, the passive investor sleeps soundly through the night while things get fixed.
Further, less knowledge and experience is required to be a passive investor, as it does not require a deep understanding of the real estate market and the asset class you plan to invest in, be it single-family homes, apartments, retail, or other commercial or residential properties. Active investing would necessitate a thorough knowledge of the market in which you plan to operate and the ability to distinguish between good and bad real estate transactions. Passive investing does not demand that you be an expert in real estate, as the passive investor leverages the skills, network, and expertise of seasoned professionals.
There are great tax advantages to real estate investing, too. All real estate investors, even passive ones, enjoy the income, appreciation, and stability of their asset, while also enjoying various tax perks such as write-offs for depreciation, even as a passive investor— and yes, you read that right: An asset appreciates, but you get a depreciation write-off at the same time!
Passive investing also offers great opportunities for risk diversification. As a passive investor in a real estate project such as crowdfunding or a real estate syndication, you may combine your money with other investors to buy a more significant, more stable asset than you could afford or would want to risk purchasing on your own. As a passive real estate investor, you have the opportunity to invest in different markets and asset classes, and the ability to spread your equity across multiple projects, diversifying your risk.
Getting started as a passive real estate investor
Joining a real estate syndication is an excellent method to begin as a passive real estate investor. Syndications are organizations of real estate investors that collaborate to acquire lucrative real estate projects such as multi-unit apartment complexes.
When it comes to real estate syndications, there are generally two participants: The General Partners and Limited Partners, also known as its passive investors. General Partners are active investors in the project, those in charge of locating and underwriting the property, the contracts, capital, and vendors. A Limited Partner in a real estate syndication essentially provides a portion of the capital to acquire the asset. Limited Partners receive monthly or quarterly updates on their investment, and passive income distributions.
A theoretical example
Let’s suppose there’s an apartment complex that is going for $10 million. It’s in a prime section of town, so it should be a safe investment. The General Partners (GP), also referred to as real estate syndicators, will work with a lawyer to form the LLC, create the business plan for the building, and model the returns to investors. In this case, the plan is to increase revenue and appreciate the property value. The GP needs to raise some funds to purchase the property and do a little value-add remodeling. A 20% down payment is necessary, so they recruit 40 investors to put down $50k each ($2 million) at a shared 70% ownership value, and kick in $1 million for remodeling costs.
As a passive investor, you would look at the pitch and see if it seemed like something you would want. You would review the GP’s business plan, which discussed 8% preferred returns, paid monthly for five years, and an end-game equity split. If the syndication hits the bare minimum, you will receive monthly checks of $333.33 (8% x $50,000 at 12 months per year) for five years, and then receive your share of the complex when they resell it to other parties.
Let’s say the GP holds onto the complex for five years. You would have collected $20,000 in monthly deposits during that time frame. Additionally, now the balance on the mortgage is $7 million instead of $8 million, and the property has appreciated 20% to $12 million. So, when they sell the multifamily property, there’s $5 million in proceeds, 70% of that, or $3.5 million, going to the 40 limited partners. Therefore, you’ll receive $87,500. Over five years, you’ll have collected $20k in rents and $87.5k from the property sale, meaning you will have more than doubled your money!
Of course, there is risk with any investment, but passive real estate investing has the potential to be one of the most efficient ways to build wealth over time. It takes very little work, is scalable, and diversifies your portfolio into one of the safest asset classes, that of real estate!