When it comes to investing in real estate most people do not know that they can passively invest in deals. What are the differences between passively investing with a sponsor or actively investing on your own? There are many benefits to both, however I’ll share a few with you so you can see what makes more sense for your particular need and situation.
“It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.” — George Soros
Probably one of the most important factors to consider is time.. Time meaning do you have the time to become an expert in real estate, do you have the time to find amazing deals, do you have the time to deal with financing and getting the loan, do you have the time to manage the properties and deal with the tenants, do you have the time to fix things when stuff goes wrong (because trust me, there are always unexpected things that occur that will need your attention right away), and do you have the time get everything legally compliant (with the attorney, CPA, Secretary of state and everything else). I mention time over experience and knowledge because if someone has the time they can obtain the knowledge and experience (it will just take a long time).
Another important factor is what is your current occupation and other interests. For example, If someone is working a full time job or a career that they love and they want to excel in that career or job then investing with someone they know passively gives them the freedom to continue growing in their primary objectives. Back to the example, lets say John Smith is a mechanical engineer and recently graduated college. He has been at his current company for two years, and wants to find a higher paying job at a more well known company. He has already started studying for new certifications which will look better on his resume when applying to new places. He loves his field of work but likes real estate and wants to invest. He already owns a home. Investing passively is perfect for him because he can allocate a certain amount of capital with someone he knows (who is already an expert in real estate) and not have to think about it again. The person he invests with takes care of everything. John just sits back and receives checks.
Next is Mary Sue. Mary Sue is 45 years old and is a teacher. She has a 401k for her retirement but like most people she lost a lot of it during the housing market crash of 2008. She is scared because of all the volatility in the market place recently. She has been learning about real estate and likes the idea of investing but doesn’t have much money saved from her salary. She discovers that she is able to “self direct her 401k” and decide where her money goes (this means she can buy real estate with it) instead of it being controlled by someone she doesn’t know in Wall Street. Again, if she has the time and the know how, she will be able to self direct her 401k and buy a piece of property by herself. She is scared of doing so because of her lack of experience. Her second option would be to invest her 401k with a professional who has the experience and knowledge and lessen her risk. It will lessen her risk in a big way because by herself she can only afford to buy a house or duplex with a small down payment. If any issues arise like tenants not paying or unexpected repairs she could potentially lose the property and her investment. If she becomes a part owner in a larger deal, she will have reduced her risk because it will have multiple tenants (so if one doesn’t pay there will be others to reduce break even point) and it will be managed by a professional that is 100% focused on making sure everything is running smoothly.
As you can see there are very strong reasons why someone would want to make a passive investment rather than try to buy a deal on their own. Below are some bullet points to lay out the pros and cons of each.
Pros of Passively Investing
- Freedom to pursue other goals and hobbies (career, fitness, family etc.)
- Reduce overall risk by having a professional 100% focused on investment
- Able to be a part of larger deals otherwise unavailable just by yourself
- Receive tax benefits of investing in real estate (depreciation and ride offs)
- Receive “mail box money” without having to do any work
- Know in what your investing in, instead of letting someone in Wall Street you never met invest your 401k
- No need to spend years of trial and error to get good at real estate investing
- You don’t have any liability if the property owner/company is sued
Pros of Actively Investing
- Pleasure of knowing you executed the plan (when things go right)
- You get to make all the decisions
- You receive all the benefits for all your hard work
Cons of Passively Investing
- You don’t make the investment decisions
- The tax benefits are divided up based on how much money you put in
- The profits are divided based on how much money you put in
Cons of Actively Investing
- Valuable time spent away from the family
- Lots of heartache and failures
- Takes a long time to get good at everything necessary
- Could cause strain on marriage and relationships
- You could get sued
- Higher risk of failure
So when it comes to investing actively or passively there are a lot of things to consider. I hope to have been able to add value to you and shed some some light on the pros and cons of each. If you would like more information or have any questions, you can reach me directly via email at firstname.lastname@example.org