If you’re new to real estate investing, you’ve probably wondered whether you should invest passively in a real estate syndication or whether you should just go out and buy your own property directly. This is one of the fundamental decisions you will need to make as a new investor.
There are four key questions you need to ask yourself in order to discover the answer.
For the purpose of this article, when comparing “active” vs. “passive,” we’re going to limit the conversation to real estate syndications.
“Active” investors in this sense are the general partners, the operators, the sponsors, or the managers, all of which can be used interchangeably. These are the folks that have dedicated their time and effort to find, close and operate the property.
“Passive” investors in this sense are the limited partners. These are the folks that have capital and partner with active investors in exchange for a projected return on their money. They leverage the active investors’ time, network, experience and expertise to gain access to commercial real estate deals.
- How much time do you have?
This is one of the first questions I ask when having a discovery call with investors.
For most people, the answer is not a lot. We’re busy people. We have successful careers and those careers take up the lion’s share of our time in any given day. We also have families and friends that need our time and attention. Perhaps we already have a side hustle or a passionate hobby, that again, requires time.
That being said, the more time you have, or at least the more flexibility in your schedule that you have, the more likely you’ll be able to handle the additional responsibilities that comes with managing an active portfolio.
Speaking from experience, it is not easy to find, buy, fund and operate a 100+ unit apartment complex. Just to find one good deal, you have to build your network of partners and vendors, and constantly stay in contact with brokers. On average, sponsors will underwrite 100 deals, submit offers on 10 and win 1. Those numbers are expanding as competition continues to grow.
To close the deal, you need to leverage relationships with due diligence vendors and lenders. You need out-of-pocket “at-risk” capital to conduct due diligence on the property, which can add up to hundreds of thousands of dollars. You need a net worth equal to the loan amount and a liquidity equal to 10% of the loan amount in order to secure the financing. You need a passive investor network to raise millions of dollars in equity as a down payment for the loan. Once the deal is closed, you need to execute the business plan by managing the property manager and contractors, project managing the construction, leasing up the property and ultimately executing the entire business plan.
All of this takes up time.
- What is your personality type?
Do you like being in control and hands-on, or would you prefer to let someone else handle the heavy lifting? Many of us suffer from the hesitation to relinquish some control, to delegate, and to focus on what we’re the best at.
If you can’t let go of some control and you’d prefer to handle all the decision making and oversight of all of the tasks mentioned above, you may need to go the active investing route. However, that’s easier said than done depending on your availability and experience.
Another relevant question to ask yourself is, “How risk averse am I?” As a limited partner or passive investor, your liability is limited. Only your invested capital is at risk (which is inherent in any investment). If someone slips and falls at the property, you will not get sued personally. No one can touch your personal assets. On the other hand, if you are a general partner or sponsor, you will almost certainly be named in a lawsuit, whether successful or not. Sponsors not only assume the liability risk for things that may go awry at the property, but they are also ultimately responsible for the debt. It is the sponsors, not the limited partners, that sign on the dotted line of the loan documents and guarantees.
- What is your experience?
Do you have real estate investing experience? I’m not talking about trading shares of REITS on Robinhood or becoming a “landlord by accident” by renting out your first home. I’m talking about specific experience buying and operating a 150 unit apartment complex, an 800 unit self-storage facility, a 100 unit build-to-rent community or a 1,000 bed senior living development.
Commercial real estate is complex, intricate, and nuanced. Specific asset types require specific knowledge and experience. If you want the consistent, high upside returns that institutional quality, commercial real estate investments offer, you need someone on your team with specific experience and expertise.
This is one of the most beautiful aspects of passive investing. You can leverage the experience of experts in their particular asset types, and partner with them to mitigate your risk give you the best chance at above-market returns. For most busy professionals trying to find life balance between family, work and play, the lifestyle afforded by passive investing is the way to go.
Your run-of-the-mill YouTuber will tell you commercial real estate is simple. While the fundamentals of real estate are generally simple, actually executing these deals at a high level that will deliver consistent returns is a high stakes game full of pitfalls. If you want to invest actively, it is imperative that you build up a deep well of knowledge, experience and relationships. If you have the time, energy and desire to build up these requirements, active investing can be a very rewarding game.
All that being said, everyone starts somewhere. When someone is on the fence about investing passively or managing their own active portfolio, I tell them first, get educated. Second, find a mentor. Third, invest passively. Then, if you know that this is your game, invest actively.
- What are your investing goals?
Are you seeking immediate cash flow so you can start replacing your active income? Are you seeking long term capital growth appreciation? What is your risk appetite? Do you want to get out of your current job yesterday? Do you love your career but would like more freedom, flexibility and fun? Do you live for the adrenaline rush of finding and closing a deal, or would you rather sit back, sip coconuts and collect checks?
Your age and financial status come into play here. If you have $500,000 or more to invest and can reduce some of your outgoing expenses, we can work on a plan for you to invest passively and you can be retired within a year or two. If you have less capital, but are interested in getting started passively, we can partner on a single deal and give you a peak behind the curtain so you can see how it all works. Then you can decide if you want to keep collecting mailbox money or start learning how to operate an active real estate portfolio.
So which is better, active or passive? There’s no right answer here. This question can only be answered by you from the perspective of your unique situation.
Ask yourself the fundamental four questions:
How much time do you have?
What does your personality say about your real estate investing thesis?
How much experience in commercial real estate investing do you have?
What are your investing goals?
No matter what you decide, we are here to educate you, point you in the right direction, change your mindset and get you to take action. Cheers to your success.