What Type of Investor to be When I Grow Up: Active or Passive
Let me define a couple of terms before I unpack my opinions. Firstly, for the sake of this article, “landlord / active investor” is defined as an investor who purchased a property as an investment and plans to actively manage it, on the flip side, a “passive investor” is someone who invests in someone else’s managed properties (we will use an example of limited partner investing in a syndication). There are benefits and complexities to every real estate investment opportunity, so if you are exploring various options, I would like to share lessons-learned from my extensive experience as a real estate investment entrepreneur with years of experience as a landlord in Philly, North Jersey and in Miami, as well as both, an active and a passive investor in multiple commercial real estate syndications.
Tread lightly through your decision tree because you may just end up with more than you bargained for. Allow me to provide you the pros and cons of becoming a landlord / active investor vs. a passive investor.
So, you wish to be the Lord of the Land
There are many benefits to being a landlord; a landlord is basically a business man or business woman. The landlord makes important everyday operational decisions from expenses to lease terms – you decide if a prospective tenant is acceptable and what rent the market can bare; as well as making strategic decisions such as the level of renovations and when to refinance or sell the property.
In short, you are the boss, and that alone is terrifically rewarding!
When I first dived into real estate investing, I bought a couple of properties; one in Philly and another in Miami. Why did I buy rental properties, you ask? Well, the most appealing prospect for me to became a landlord was income. This is certainly the main reason why most investors want to be a landlord. When the stars line up, and nothing needs repairing and the tenant pays on time, you can count on a decent slice of income that covers the property mortgage, while the property appreciates in value. Even more so, if you own the investment property then it’s an even better prospect.
Be careful, however, because at initial sight, being a landlord looks to be fairly easy; it’s awesome that you get rent money from tenants every month for not doing much. In fact, the control that you exert over your active real estate commitment is directly proportional to the time that you will need to spend in managing the activities related to your investments. Well, I can tell you first hand that being a landlord is actually intricate, laborious, and requires to be able to quickly understand legal and financial landlord-tenant requirements and ramifications.
You have to be ready to treat your rental properties like a business, which means that you will be required to make time for to either hire a management company or personally take care of business needs, such as painting, cleaning, and showing your rental property to prospective tenants (this is what I did many times to save on expenses). Don’t be too surprised to walk into your vacated investment property to find it in shambles only after a year it was refurbished. I found that any miscalculation on renovation costs or rental prices of a property caused a reduced profit or a loss altogether. The issue is that for a landlord, this profit reduction or loss is much more deeply felt than by passive investors since the loss is spread around the group that hopefully has a sponsor that can boast past performance of risk mitigation.
Sooner or later you also will have to take legal action against a tenant, at least I know I had to, and that’s what many of my colleagues tell me as well. My current tenants are awesome, however, more times than not, my tenants were far from that. Even after vetting tenants through credit checks, I was surprised that most tenants (across wide salary ranges and social circles) had to be reminded to pay their rent, and others were just not dependable or trustworthy at all. I recall instances when tenants were two to three months late with their rent.
So you would like to sit back and watch your money grow?
As I mentioned in the beginning of my article, a passive investor is analogous to being a limited partner in the real estate investment. You and other passive investors invest your capital with a knowledgeable and skilled syndicator. Only the syndicator has direct control over the business plan of the investment, so as a limited partner one of your responsibilities is to trust the syndicator. But your primary responsibility above all else is to evaluate the knowledgeable, professional and qualified syndicator based on your mutual interests before ever investing with them. In my previous articles, I listed aspects of passive investments that you need to consider, such as a preferred return for example, where you will receive a return on your investment first to make sure that the syndicator has a financial incentive to give their best effort to the investment property.
Another terrific benefit of passive investing over active is that it passive investing is relatively stress-free. You are not the landlord, so you don’t have to know about daily issues that constantly crop up, much less worry about mitigating them. As I said above, all you need to do is to carefully evaluate the syndicator and the investment. From there on, your post-investment responsibility is to read the monthly or quarterly project updates.
The best deal of all is that your risk as a passive investor is hugely minimized. Passive investing is generally a widely used investment system, and the particular passive investment that you will consider will be executed by a syndicator what has a proven success track record. How do I know this? Because you just finished reading my article, and I am certain that you took every point in it under careful consideration!
What path will you set on: Active or Passive Investing?
Only you know your financial circumstances, your need for control and aversion to risk, as well as your investment goals. As an active investor, you will spend lots of time on your investment and, don’t kid yourself; you will be stressed while managing your investment, but the skills and experience that you will learn will be invaluable. The vast variety of investors, however, will tend to invest passively, partly due to lack of time or desire to manage the investment 24x7; but in reality because there is no real need to since their investment and their syndicator will manage the investment for them.