Guide to Passive Real Estate Investing

Passive real estate investing is a smart strategy for individuals looking to generate income and build wealth without actively managing properties. This investment approach involves putting money into real estate projects or properties and earning returns without the day-to-day involvement typically associated with property ownership.

Essentially, passive investors provide the funding and leave the operation and management of the property to professionals, such as real estate syndicators or property managers. This hands-off approach allows investors to diversify their investment portfolio and benefit from real estate appreciation and rental income without the responsibilities of being a landlord.

Continue reading to learn more about passive real estate investing.

How Does Passive Real Estate Investing Work?

Passive real estate investing is an umbrella term for different ways to put money into real estate to earn a passive rental income. You invest your money, but your responsibility ends there.

In most forms of passive real estate investing, someone else does all the work of buying, managing and selling properties while you reap the benefits. You’re not building a real estate portfolio but effectively benefiting from helping someone else build one.

One form of passive real estate investment is buying a property and hiring a property manager to maintain it, deal with the tenants and collect the rent. Other forms of passive investing in real estate include real estate investment trusts (REITs), online real estate crowdfunding platforms and real estate funds.

Passive Real Estate Investments vs. Active Real Estate Investments

There are four main differences between passive versus active real estate investing:

1. Amount of work required
2. Experience required
3. Income earned
4. Liquidity

Owning and actively managing a property can be a full-time job. However, owning a property and hiring someone to manage it for you requires almost none of your time; other methods of passive real estate investing take even less effort.

Passive real estate investing might be considered low-risk real estate investing, but you still want to do your homework to avoid suffering a loss of principal. Still, your learning might be a few hours on your computer, whereas active investing requires the expertise to know which properties to buy and sell and when.

As a passive real estate investor, consider your investment to be long-term. Over that period, your small investment can net you thousands — or possibly millions — of dollars. The active investor might make that in a year, but they also take on more risk.

Most real estate investments are considered illiquid. Trying to turn a piece of property into cash is a slow process. Property sales can take months or even as long as a year. However, as a passive real estate investor, you can pull your money out when you want, although you might be charged a fee for taking out your money early in some cases.

How to Invest in Real Estate For Passive Income

If you’re looking to earn passive income from investing in real estate, there are many different methods of passive real estate investing to choose from, including crowdfunding, REITs, hiring property managers, real estate syndication, real estate funds and fractional ownership. Let's take a closer look at each investment method.

Crowdfunding

Online crowdfunding platforms make it easy to get started with passive real estate investing. These sites let investors pool their money to buy commercial or residential properties that generate income. You can earn cash from rental income or appreciation and a subsequent sale.

Crowdfunding sites enable beginners to jump into passive real estate investing. The sites work with their network of property managers to find and manage tenants. Your biggest concern might be the timing of distributions.

You must be an accredited investor on many sites, but several now allow nonaccredited investors. An accredited investor is anyone who has a net worth of $1 million or more (excluding your primary home) or has earned $200,000 or more in the previous two years and expects to continue doing so.

The U.S. Securities and Exchange Commission (SEC) set these criteria to ensure that investors have enough sophisticated knowledge to understand high-risk investments. There’s no certification or designation from the SEC — it’s left to each site to verify that you meet the criteria.

Real Estate Investment Trusts (REITs)

The concept of a REIT isn’t unlike crowdfunding in that REITs are companies that own and operate real estate properties that generate income. However, REITs are mostly traded on the major stock exchanges. You can invest in individual REITs, mutual funds and exchange-traded funds (ETFs).

This option is similar to owning a share of stock and being paid a dividend. The SEC requires REITs to pay 90% of their taxable income to shareholders. You can invest in residential or commercial REITs and choose between different economic sectors, such as healthcare or hospitality.

Using Property Managers

Buying a property and hiring a property manager to maintain it, interact with tenants and collect rent is a type of passive real estate investing. You may or may not have been involved in selecting and purchasing the property, but now, you can sit back and accumulate income while someone else makes the decisions about your rental.

Another benefit of having a property manager or management company run the show is that you can buy properties in other locations because you don’t have to be there to oversee things. Of course, having someone else manage your property could also be a drawback, so choosing an individual or company with professional experience is important.

What you pay a property manager will depend on what you want done (being completely hands-off costs more). The average cost of a property manager is between 8% and 12% of the monthly rent, plus other fees, which may include:

• Set-up fee
• Tenant placement fees
• Lease renewal fees
• Maintenance fees
• Eviction and collection fees
• Late payment fees
• Routine inspection fees
• Contract termination fees

Numerous factors impact the cost of a property manager, including the quality, size and condition of the property and your market. As such, the lowest price might not always be the best.

Real Estate Syndication

In a real estate syndication, you can pool your money with a group of investors, forming a partnership to invest in a single property.

There are general and limited partners, and your rights in the partnership and potential returns are relative to your investment and liability. There also can be three other players: the passive individual investor, a managing entity and a joint-venture partner.

General partners (also known as syndicators or sponsors) strategize and bring passive investors on board. Passive investors provide capital; limited partners are less liable counterparts to general partners; managing entities collaborate between partners; and joint-venture partners offer resources to help ensure the success of a project.

The SEC doesn’t require a particular legal business structure. However, most syndications form limited liability corporations (LLCs).

Real Estate Funds

There are four general types of real estate funds: real estate mutual funds, REITs, real estate private equity funds and real estate debt funds.

To understand real estate funds, consider the example of a mutual fund, which is a collection of several types of investments. Those investments could be stocks or bonds or track an index. A real estate fund is similar, except you’re investing directly or indirectly in real estate.

Here’s a brief breakdown of the funds:

• Real estate mutual fund: Publicly traded; investment in stocks and bonds of real estate companies or directly in properties
• REIT: Publicly traded; owns and operates income-generating properties and pays dividends
• Real estate private equity fund: Not publicly traded; pools money from individual investors and invests in specific properties
• Real estate debt fund: Not publicly traded; pools money from large institutional investors for the development or redevelopment of large commercial properties

Because real estate private equity funds aren’t on the exchanges, they carry an illiquidity premium that’s attractive to investors. These funds also tend to have less volatility than others because of diverse investment strategies and a low correlation to public equity and bond markets.

The skillful management of real estate private equity funds can generate an excess in returns beyond market movements, which is referred to as “alpha.” Seizing these opportunities is known as “tapping into alpha.”

Fractional Ownership

Fractional ownership offers a way to pool your resources with others to buy a property, such as a vacation home, house or condominium. Each investor owns a share of the property, and the value of these shares changes with the property value.

As a fractional owner, you have a say in what happens with the property. The cost of managing the property is spread across all owners, but you also share any rental income generated.

Fractional ownership can take several forms, including joint tenancy, which gives you equal rights and access to the property, and tenancy in common, which gives you a partial interest in the property.

Benefits of Passive Investing

Some of the many benefits of passive investing include:

• Low entry costs
• Little knowledge needed
• No physical labor
• Liquidity
• Reliance on real estate professionals

These advantages make it a great low-maintenance money-making opportunity.

Risks of Passive Investing

That said, passive investing is not without potential downsides, including:

• Unpredictable real estate values
• Less liquidity than stocks and bonds
• Less control over investments
• Long-term holding

These disadvantages are worth weighing if you’re considering getting involved in passive investing.

Compare Real Estate Investing Platforms

Consider Whether Passive Real Estate Investing Is for You

If you’re looking for an investment that promises to generate cash flow with little work on your part, passive real estate investing might be a viable option. Just make sure you explore the contours of this type of venture carefully to avoid putting your money into something that doesn’t perform the way you expected.

Frequently Asked Questions