Should I Actively or Passively Invest In Commercial Real Estate?
“Financial freedom is available to those who learn about it and work for it.”
— Robert T. Kiyosaki
Investing in commercial real estate can be done via two main strategies - active and passive - that are fundamentally at opposite ends of the investor spectrum. Each strategy represents a different mindset and level of effort to be successful. Depending on the perspective of the investor, each strategy may be viewed as having its advantages and disadvantages.
Active investing is a hands-on approach whereby the active investors are expending time and effort ("sweat equity") and making crucial decisions affecting the investment, and therefore, the performance of the asset. In a syndicated real estate opportunity, the sponsors are the active investors or partners who make various contributions to the success of the deal such as identifying and packaging the deal, obtaining financing, managing the property, and attracting investor capital to the opportunity. In exchange for their efforts, sponsors are compensated with partial ownership of the opportunity. The importance of the sponsors cannot be overstated as being the most critical element of any syndicated investment.
Passive investing is a hands-off approach whereby the passive investors are expending minimal time and effort while benefiting from the performance of the sponsor to produce returns and distributions (i.e., passive income or cash flow). Passive investors need to meet the relevant investor qualifications depending on whether the sponsors have chosen the offering to be exempt under Rule 506(b) or 506(c).
Passive investing is an astounding way to become financially free as motivated investors can build portfolios that eventually produce enough passive income to cover all their living expenses and more. In a syndicated real estate opportunity, there can be a varied number of passive investors that invest capital to acquire a percentage of the equity ownership and corresponding portion of the cash flow and appreciation. When investing with an experienced sponsor, passive investors can leverage this relationship to obtain the following benefits:
Portfolio Diversification - passive investors are investing in asset-specific opportunities and have the ability to assemble their own diversified portfolio by carefully selecting opportunities across a range of asset classes and geographic locations. Furthermore, investors that shift their holdings from stocks, bonds, and mutual funds into commercial real estate to reduce volatility and increase returns.
Tax Benefits - depreciation (also known as passive loss) could be used to reduce the tax consequence of passive income. Professional investors may utilize this strategy to pay little, if any, tax.
Financing - passive investors utilize the financing capabilities of sponsors to obtain favorable loan terms and conditions.
Expertise - passive investors utilize the years of experience and knowledge of sponsors; passive investors can carefully select the best in class sponsors with whom to invest.
Time - passive investors have very little responsibility and time committed to the investment. The lack of commitments to the investment gives investors a chance to pursue other endeavors such as identifying other passive investment opportunities.
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