Posted almost 2 years ago

Three Key Routes for Passive Real Estate Investing

I began my out of state real estate journey some five years ago, and along the way I have discovered that there are really three primary routes (or categories) for arriving at the destination of achieving my real estate passive income goals. They are turnkey buy and hold, private lending and participating in real estate syndications. I have traveled each of these routes and continue the journey, taking a side road here and there.

Turnkey Investing – The Road Most Traveled
First off let me clarify what I mean by this term, since it is so oft used in various ways by sellers and others. To me true turnkey, means working with one of the many turnkey providers who do all the work of acquiring a distressed property, fully rehabbing it leaving no deferred maintenance, and placing a tenant - preferably with their in-house property management (PM). If they don’t have PM in house, then they should be closely working with a preferred PM. By the time I close on the deal, all of this has been done (sometimes tenant placed shortly after close), and I start cash flowing from day one (or very soon thereafter). The properties are all residential single family (SFR) or small multifamily (MFR) of 2-4 units. Since, I am buying a fully rehabbed and performing property, it can be conventionally financed from the get go at the best interest rates and pricing available. Assuming good credit and debt ratios, this is an easy way to buy with 20-25% down plus closing costs.

Additional Advantages

  • I own it and control it. I ultimately make the big decisions about what happens to this property over the short term and long term. These include who manages, what I will do with any equity, and when to sell, refinance or anything else.
  • A Real Investment: Maximum tax advantages of real estate, including writing off interest payments (if there is a loan) and depreciation over 27.5 years. Also eligible for 1031 exchanges.
  • I can have it inspected professionally, as well as inspect it myself, when the work is complete and before I own, minimizing my risk for incomplete or poor construction.
  • Tenant is paying down principal on mortgage if any, adding to the equity over time.

Some Disadvantages

  • I own it and control it. Once the property is mine I am dependent on the PM whose interests are not necessarily aligned with mine. No one else is going to care as much about that property as I do. And it is a long ways away. Having a great PM is crucial, but not always achievable. Keeping quality tenants happy and in place over a long period of time becomes the hoped for outcome.
  • Not at all liquid. I probably bought this property at market price or close to it. Simply put, selling before a 5-10 year period in a market that is only slowly appreciating means I will likely take a loss due to selling costs. Quite possibly the only buyers will be other investors who are always looking for a bargain.
  • Often Not As Passive As It Seems. As a turnkey investor who likes to be kept informed and in control, I find managing the manager is essential. The best will communicate well and handle issues with as much ease and grace as possible, but there are always going to be issues that arise.

Private Lending – A Lesser Known Route

Who knew this was even possible other than between family and friends? Certainly not me when I got started. My first private lending was to the same company I started my turnkey investing with, using self-directed retirement funds. In short, this is a way of becoming the bank to another investor or investment company. These loans can be made to flippers who sell to other investors (turnkey) or retail (owner occupiers), private investment firms (read: hedge funds etc), or to a friend or family member. Private loans are structured any of number of ways, but should always include a promissory note (note) and a mortgage that secures property as collateral. The property secured doesn’t have to be the property being bought and rehabbed. It could be against another property or properties. The important thing here is realize that a 1st lien position is critical for true security. However these take larger loan amounts to obtain in most cases. I have personally done 2nd lien positions for smaller amounts, but it was with a company that had several years long track record of paying on time with full repayment 100% of the time. Typically these loans pay a straight annual interest rate of 8-12%. Some will go higher, but those usually carry more risk or are reserved for bigger players with lots of capital, like Hard Money Loan (HML) companies. In some cases a point or two of origination is possible. These loans are usually short term of 6-18 months or so.

Advantages

  • Nearly Fully Passive. Once due diligence (DD) on the borrower is fully done and the loan is made, there is no further involvement made. Totally hands off on the real estate.
  • Known Returns with no Variables. I know exactly what the return on investment (ROI) is going to be from the get go.
  • Lower Risk. Assuming proper DD has been done, with a rock solid borrower and secured property is worth considerably more than the investment (65% LTV at most).
  • Greater Liquidity. Ties up funds for a shorter amount of time.

Disadvantages

  • No Tax Advantages. This is just like earning interest on your bank account.
  • Frequent Turnover. Can leave gaps in putting the money to work between loans. And that is also when it becomes not so passive.
  • No Control. Goes with being passive.
  • Usually Requires A Large Investment. $50,000 and up

Syndications – Scenic, Greatly Varied, and Not for Everyone

Syndications come in many forms in real estate, and can have elements of owning property (Equity) or making loans (Debt) or a combination. What defines syndications is that it is bringing together a number of investors together for the investment. As a passive partner in the syndication I hold a fractionalized share of the investment. This is known as a security, and will fall under some set of SEC rules. Most syndications are open only to accredited investors, but I am seeing an increasing amount of openings to non-accredited investors especially through crowdfunding under changing SEC rules. In fact, all the offerings of the only crowdfunding company I’ve invested in so far are open to non-accredited. Crowdfunding is merely a form of technology platform used to efficiently bring a larger pool of potential investors to the syndication table if you will.

More on my Crowdfunding Experience: Have I Found the Holy Grail of Passive Real Estate Investing?

Advantages

  • Access to Bigger Deals. Including land development, housing development, large apartments, commercial real estate, as well as packages of residential properties.
  • Shared Risk. Definitely not in this alone, and depending on how the deal is structured, passive investors interests can be very aligned with the project managers.
  • Greater ROI. At least the potential can certainly be there.
  • Generally Very Passive. This can vary via the amount of due diligence needed up to the time of investment.
  • Some Very Low Entry Points. This is by way of the crowdfunding platforms. $1,000 to $10,000 is typical, but have seen as low as $100.
  • Tax Advantages on Some Buy and Hold Equity Deals.
  • Short to Medium Term. Varies widely.

Disadvantage

  • No control. Beyond making the decision to invest, the rest is up to the project managers.
  • No Tax Advantages on Many of These Deals.
  • Widely Varying Degrees of Transparency. I like to know what I am getting into and how it is performing.
  • Complexity. Many of these deals can have a lot of moving parts and players.

Of course all of these routes are open to travel. Where my metaphor breaks down is that they can all be traveled concurrently, or not. Beep beep!



Comments (20)

  1. Thanks Larry. Great read for newbie like me.  Really appreaciate it.

    Kay


    1. You are welcome @Kay Rahi!  I am glad it was helpful.


  2. Larry,

    Thanks for this and the 'holy grail' posts. My rental properties are in the NYC suburbs of NJ, and I wonder if its time to cash out of some of these and invest in other mini boom-towns with better ROI. The crowdfunding channel sounds like a great way to diversify, with proper DD, as you mentioned. 

    John


    1. Thank you for reading @John Hessell.  Sounds like you've got some avenues to explore.


  3. Great article Larry. As a new investor, I will be pursuing each of these methods for a balanced portfolio. 


    1. Thank you, Kevin!


  4. Hi Larry.

    Can you comment on which crowdfunding sources or sites you prefer and why?  


    1. @Austin Realty There is only one crowdfunding platform that I have invested with, and I have written extensively about my investments with them, including quarterly updates in my 4 part blog series Have I Found the Holy Grail of Passive Real Estate Investing?


  5. Larry - thanks for giving this summary of 3 different investing strategies. I'm new to this world and considering options. 


    1. You are welcome @Elizabeth Yoshida.  I am glad it was a valuable read for you.


  6. Larry you mention: “

    • Tax Advantages on Some Buy and Hold Equity Deals.”
    Can you talk about that?

    1. Simply: On syndicated buy and hold deals there is the depreciation allowance deducted.  If leverage is used to buy the deals by the syndication, then there is also a mortgage interest deduction allowed for.  However if investing with retirement accounts, none of these are relevant.


      1. But for me, and I assume others, the advantage of a retirement fund being pre-tax money, and being able to pass the stepped up basis to heirs outweighs mortgage interest and depreciation allowance deductions. 


  7. Larry on the turnkey rentals what has your CoC been? 


    1. Generally in the low to mid teens ConC.


      1. Larry

        Any teen ConC is great, as far as I understand.

        Where exactly do you get that kind of return on turnkey? Seriously would love to know. 

        If you can, please message me.

        Thank you

        Awais 


  8. “It would be interested to do a hypothetical spreadsheet comparing each of these methods, plus a buy and hold rental, over a 10, 20, 30 year term, and see which comes out head.”

    I would be interested to see that comparison


    1. That would be interesting.  I doubt such a comparison exists.


  9. Hi @Tina Huffman.  Sure.  This paragraph is from the Advantages list of Private Lending.  It translates that it is a lower risk investment generally then buying turnkey  property. This assumes the investor (lender) has done the proper due diligence on the borrower, to the point where default seems highly unlikely.  Risk is also minimized by the loan being backed by a note on a property lending at no more than 65% loan to value.

    Does that make it clearer?


  10. Hi Larry, can you explain what you mean by the following:

    Lower Risk. Assuming proper DD has been done, with a rock solid borrower and secured property is worth considerably more than the investment (65% LTV at most)

    I wasn't following the meaning there.  

    It would be interested to do a hypothetical spreadsheet comparing each of these methods, plus a buy and hold rental, over a 10, 20, 30 year term, and see which comes out head.