Let’s say that you own a rental house, residential duplex, self-storage facility, or office building. And, let’s also say that, while you appreciate the cash flow you’re receiving from the property, you’re tired of the trash, tenant, toilet, and management issues that are part and parcel with ownership. Basically, you like the returns, but dislike being a landlord.
Passive investment is an option to consider if you don’t want to deal with the downsides of direct real estate ownership. As a passive real estate investor, you can enjoy the benefits of owning property, without dealing with the heavy lifting.
Active Versus Passive
The concept of active investment is fairly self-explanatory. It means that you are active in the real estate ownership process. There are many different ways to structure an active real estate deal — Double Net (NN) vs. Triple Net (NNN), for example — which can ultimately affect your degree of activity as a landlord. Generally, you select the property. You obtain the financing, and are personally liable for paying off the loan. You take care of the property during your hold. You find the tenants. You make management and recapitalizing decisions. You replace the roofs, and take care of the landscaping. And, you sell when you feel it’s the right time.
The similarity between active and passive investing is that both require capital. Otherwise, as a passive investor, once you put money toward a real estate acquisition, that’s it. Ultimately, the investment’s structure will impact the degree of passiveness. But with a passive investment, the investor’s goal is ultimately to sit back and enjoy investment income without the hands-on hassle. Someone else handles the financing, the maintenance, the tenants, and the selling.
A Myriad of Options
Several options exist when it comes to passive investment property vehicles. The more common types are real estate funds, Delaware Statutory Trusts, Real Estate Investment Trusts, and crowdfunding.
Real estate funds, similar to mutual funds, are professionally managed. As a fund investor, your money is combined with that of others, with the combined capital then used to buy either properties, debt, or real estate-related securities. These are generally under a General Partner and Limited Partner structure.
Delaware Statutory Trusts, or DSTs, are similar to real estate funds, but are legal entities created as trusts under Delaware state laws. The underlying investment is commercial real estate, but unlike what the name implies, neither you or the properties have to actually be in Delaware. As a DST investor, you acquire, and own, a beneficial interest in the trust, a concept known as fractional ownership. The trust pools funds from you and other fractional owners, then buys (if not already acquired), maintains, and sells the underlying properties. As a fractional owner, you are entitled to potential distributions and your proportional share of any appreciation when the asset is sold.
Meanwhile, real estate investment trusts -- REITs -- have little in common with either funds or DSTs, except for the fact that real estate is the asset of choice. REITs sell shares of stock to raise capital, which is used to acquire properties. As a REIT stockholder, you own shares of a real estate investment trust, as opposed to having direct fee-simple ownership in the property. With a public REIT, you are exposed to the broader volatility of the stock market, and potential contagion of economic swings.
Finally, crowdfunding is a relatively new method of real estate ownership, combining aspects of both active and passive investment. From an “active” standpoint, you decide what real estate to invest in, and the crowdfunding portal matches you with, and performs due diligence on, sponsors and properties. Once the deal closes, you become a passive investor, with the sponsor taking on property management duties.
Crowdfunding deals can involve debt-based investments (which pay you a fixed monthly amount) or equity stakes in properties (in which you receive ongoing revenues from the asset). Similar to real estate funds, crowdfunding sites also use General Partner and Limited Partner structures.
As mentioned above, the main benefit of passive investing is that the buying, funding, maintenance, and selling of real estate property is out of your hands, and if done right, put into the hands of more capable expert institutions. You simply invest the capital, with the expectation of reaping the returns. This is not to suggest, however, that passive investments are perfect. Issues to consider before diving into this form of real estate ownership include the following.
- No direct control. Though you own the real estate through a passive investment, that’s about all you do. You have no say in how the property is managed, funded, maintained, or even when it is sold. You also can’t make decisions on what to buy. These choices are made by the entities that are put in place as managers, such as the sponsors or real estate operators.
- Lack of liquidity. Real estate, in general, is an illiquid asset -- in other words, it’s not something you can immediately pull money from, if needed. Passive investing adds another challenge to liquidity, as money isn’t available at your discretion. As an active real estate investor, you can turn the tangible asset into cash, either through sales or refinancing. Generally, you can’t do this as a passive investor. There could be, however, limited ways to generate near-term cash, if structured correctly. The exception to the above is REIT ownership, as it is easier to sell the securities. However, market demand and liquidation provisions will dictate how much you might (or might not) receive from selling those shares.
The Right Move?
Needless to say, any kind of investment requires careful evaluation, as well as an understanding of your risk tolerance and investment goals. Still, if you want to get away from the downsides of being a landlord, passive real estate investing could be a good option.
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