The Difference Between Investing and Working in Real Estate

by | BiggerPockets.com

I think one of the most important things for real estate investors to be educated on and aware of is what they are getting themselves into when they decide on a particular investing strategy.

For the record, I don’t think any strategy is the wrong way to go. I only think a strategy is the wrong way to go if you chose it naively with no idea what you’re getting yourself into. And in those situations, it may not actually be the strategy that is wrong… It may just be that the strategy is wrong for you.

With anything in life, and especially with investing and entrepreneurship, education and self-awareness are huge.

If you’re educated about what really goes into an investing strategy and you have self-awareness surrounding your goals, skills, and interests, and you can weigh those things against each other, you will be miles ahead of the crowd.

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The Definition of Investing

If I pull up the handy Google and ask for the definition of the word “invest,” this is what I get:

Invest: 1. Expend money with the expectation of achieving a profit or material result by putting it into financial schemes, shares, or property, or by using it to develop a commercial venture.

I want to highlight two words in there—expend and money. Notice it only specifies money. So if I buy some stock shares with my money, then that fits this definition. The only thing being expended is money.

Related: Introducing: The BiggerPockets BRRRR Calculator!

The Definition of Working

If I pull up the handy Google and ask for the definition of the word “work,” this is what I get:

Work: 1. Activity involving mental or physical effort done in order to achieve a purpose or result

2. Mental or physical activity as a means of earning income; employment

3. A task or tasks to be undertaken; something a person or thing has to do

Activity and tasks are the key words for me in this one. So this one is me doing something, or putting a mental or physical effort in, or what have you. Most of us are pretty familiar with this term.

Now, I’m not sharing these definitions with you because I’m trying to be condescending or explain the terms to you—I know you know what these words mean. I am including them because they very clearly show the difference in the two terms at an extremely universal level.

In one of these scenarios, money is being invested. In another one of these scenarios, effort is being invested.

Investing and Working in Real Estate

So why am I harping on these two words? Well, it’s simple. Investors oftentimes don’t seem to understand the difference when it comes to their real estate investments.

Let’s go back to buying a stock share. Is that working, or investing? All day long, that’s investing. Why? Because the only thing you are putting into it is money.

What about your nine-to-five job? Is that working or investing? No doubt, that is working. Why? Because what you are putting in is effort. (I realize some people may need to invest money into their “work” but that is a different context from what I’m talking about here.)

Those two examples are very obvious. But what about real estate investing? Where do things fall in this industry?

Well, we actually start to enter a gray area.

Let’s use flipping a house as an example. If you go into real estate investing and you decide to flip a house, is that a straight investment?

luxury-house-hack-update

Most people seem to think so. But let’s breakdown the tasks involved with flipping a house:

  • Purchase a distressed property
  • Fund rehab materials
  • Perform rehab
  • Sell property

If we were to pull down those obnoxiously haughty definitions of invest and work, do all of these components fit into the investing definition? Nope.  I see them more broken down as follows:

Invest:

  • Purchase a distressed property
  • Fund rehab materials

Work:

  • Perform rehab

We can all agree that if you only purchase the distressed property and purchase the rehab materials and then sell the property, you won’t make any money. So in this case, the key to your profits is in the work. The money you invest lends its hand toward the profits and is an important part of it—but without the work, the profits won’t appear.

So at the end of the flip, when it’s all complete and you’ve successfully flipped the property to a buyer, you walk away with a chunk of cash. That cash is usually what people consider to be the profit from their investment. But of that cash, how much of it is a return on your actual investment (i.e. the money you expended into the project)? And how much of that cash is essentially payment for the work (or sweat equity) you put into the project?

If you work a job, you are typically paid for your time and effort. You likely get paid per hour—even if you’re on salaried pay at your job, you are still worth a certain amount per hour. So you just did all the work to rehab and sell this property. For those parts of it, some of that financial return/profit is really just payment for your time and effort—just like any other job.

So how much of that profit is a return on your monetary investment (which is what investing is really about)? And how much of it is just payment for your time?

Sweat Equity

A common and fun term you might have heard is sweat equity. Sweat equity is defined as “an interest or increased value in a property earned from labor toward upkeep or restoration.”

The definition of the term really brings together this idea of having to work in and for your investments. There still is an investing component: the increase in the value of the property once you do the work on it, which is likely greater than the amount of profit that is really just paying you for your work. But work is required in order for it to come into fruition.

Understanding the Spectrum

As I’ve already suggested, there is a spectrum for which investing strategies require no work and are just straight investments (monetary only) and which ones require significant work—and everything in between.

On the far end of the no-work-required investments, you can think about investing in stocks (non–Real Estate) or notes (Real Estate).

On the far end of the work-required investments, you can think about wholesaling. In fact, I would argue that there isn’t an investing component at all to wholesaling. Instead, wholesaling is 100 percent work. You aren’t earning returns on any money you invest. You only earn “returns” for your time and effort because you are working. You may have to invest some money to get your wholesaling business going, but that’s not money you invest in the sense of straight investments.

If I were to create a very short list of investing strategies, ranging from no work required to maximum amount of work required, I might come up with:

Notes/REITs/Syndications > Rental Properties with Property Managers > Landlording > Rehabbing

With all of these, what you are looking at is how much time you have to work on the strategy in order to make it work. And therefore, what portion of your profit is from the investment itself, and how much is payment for the work you put in?

Here’s an Example

Let’s look at buying a turnkey rental property with property managers verses BRRRRing a local property that you will landlord.

You buy a turnkey rental property—the rehab is completed by someone else, the tenants are already placed, and property managers manage the property once you own it. You pay $100,000 for it, which is roughly market value on the property.

You buy a distressed property to BRRRR (buy-rehab-rent-refinance-repeat). Next, you rehab the property, place tenants in it, and then you are the landlord. Originally you bought the property for $50,000, and you did a $30,000 rehab. So you spent $80,000. The new value is $100,000. You now have $20,000 in immediate equity.

Related: How We Got a Million-Dollar Property Portfolio for (Almost) Free

The bulk of the return/profit on each property will come in the form of equity in the property—and cash flow, once it’s rented.

On the equity side, it’s clear that the BRRRR property has $20,000 more than the turnkey property. So you’re up $20,000.

On the cash flow side, both properties, in theory, bring in the same amount of cash flow. The returns are then technically higher on the BRRRR property because you’ve invested less money in it. If you are looking at the cap rate or the cash-on-cash return equations, the denominator on the BRRRR property is lower because you put less cash in—so that makes the return higher.

For help on running and calculating rental property numbers such as cap rates and cash-on-cash returns, check out Rental Property Numbers so Easy You Can Calculate Them on a Napkin.

Let’s pretend the cash-on-cash return on the BRRRR property is 12 percent. Meanwhile, it’s 8.5 percent on the turnkey property.

In both cases—equity and cash flow—the BRRRR property wins the race. On the most basic level you have $20,000 in equity on that property and you are making 3.5 percent more cash flow per month.

Now let’s think backwards. Roughly how much time is, or was, required for each property?

The turnkey rental property really only ever required you to spend time on due diligence during the purchase—and then managing the manager once it’s up and running. I’ll say you spend roughly 15 hours during the escrow period doing due diligence. Then once you own it, you spend no more than five hours annually dealing with something involving the property manager or filing insurance claims or something. That is less than half an hour a month.

The BRRRR property requires you to: find a property, negotiate the property, and then rehab the property. Finding the property and negotiating it may take you 15 hours. Rehabbing the property, at roughly a $30,000 level, may take you 60 hours. Then once you own it (and since you are the landlord) I’ll estimate five hours per month tending to the property.

On the equity front, that $20,000 profit on the BRRRR required 75 hours of work. I would also argue that in addition to the 75 hours of work—whether that be doing the physical labor yourself or tending to contractors—there is also a level of headache, thought, and stress in conjunction with the work.

On the cash flow front, an added 3.5 percent of cash flow is in exchange for 4.5 hours of increased labor (landlording) over the .5 hours for managing the property manager. Headache, thought, and stress are also likely in conjunction with the work.

Going back to my original statement at the very beginning of the article—neither strategy is wrong. Which one is correct for you depends on your personal goals and interest levels.

If you take on a strategy that requires notable amounts of work, that’s fine but realize this is actually work. So in the above examples, would you prefer to pocket an extra $20,000 and 3.5 percent per month in exchange for your full involvement in the project? Or would you prefer to pass on those monies in exchange for your freedom?

Only you know the answer for yourself.

Motivation for the Analysis

In the past, I have always invested in turnkey rental properties. Over the seven-or-so years that I’ve owned them, I’ve averaged about five hours per year working on them. When things are flowing fine, I spend almost no time on them annually. There have been a few times when I’ve had property management drama and had to fire and rehire managers. So those years, I spent some more time on them. But even then, it was fairly minimal.

When something goes wrong with the property, all I have to do is communicate with the property manager and make sure all is taken care of. But I’ve never had to rehab anything, place tenants, or call a plumber in the middle of the night.

One time a storm hit one of the properties, and all I had to do was make one call to the insurance company to file the claim, give them the property manager’s number to coordinate the visit, and that was it. (If you want to read more about that story, check out When I Prefer Property Managers over Being a Landlord)

Recently, some partners and I bought a duplex with a finished garage near where I live in Venice Beach, California. Guess who is the landlord? That’d be me.

The property was rent-ready and in great shape when we bought it, but it needed some small repairs done by a handyman. It also needed rodent treatment and termite treatment.

I decided it would be a bright idea to spruce up the backyard with new plants and mulch. In the grand scheme of things, not a ton of work. But in the month since we bought it and I’ve been trying to get it ready to list for rent, I have exhausted myself over the property. Almost every day, I’ve been up earlier than I usually am. I’m back and forth constantly from the property. I can’t tell you how many times I’ve lapped Home Depot and how many heavy bags of mulch I’ve slung around—and it’s probably double the amount of labor hours that I’ve spent thinking about the property in some manner. This is all before I’ve even listed it for rent; and it didn’t even need a rehab!

For me, with the exception of this particular Venice property, sacrificing the $20,000 and 3.5 percent/month is worth every penny if it means I don’t have to think, or stress, or put effort into my investment properties. Maybe you are different, or maybe you have more skill and interest than I do in this field, but everyone should gauge where they are and what they want before deciding which projects to take on. Swimming upstream won’t gain you more success!

Let’s poll the audience: Where does everyone fall on their investment vs. work preferences?

And how has that affected your investing decisions? Share your insights and experiences below!

About Author

Ali Boone

Ali Boone(G+) left her corporate job as an Aeronautical Engineer to work full-time in Real Estate Investing. She began as an investor in 2011 and managed to buy 5 properties in her first 18 months using only creative financing methods. Her focus is on rental properties, specifically turnkey rental properties, and has also invested out of the country in Nicaragua.

19 Comments

  1. Rob Cook

    Ali,

    Good article. This is a constant annoyance for many, the use, and misuse, of the term Real Estate Investment, or Investing. So thanks for shining some light on that.

    One thing that makes this so confusing, is that, as you said, it is not usually black and white. And understanding that there is a whole spectrum of levels of participation possible only further complicates it.

    I have always accounted for the metrics and inputs separately, as I am a construction professional. You have labor, materials, subcontractor expenses and if you are an owner-operator in real estate “entrepreneur”ship (I use that word instead of “investor” to more accurately reflect all of this confusion!), you likely have funds invested as well.

    The funds have a cost, as do all the other inputs. Even if they are opportunity costs. Still, have to be accounted for.

    Also, it is, as you stated, an individual matter whether the entrepreneur’s outcome is to maximize ROI, or maximize their own hourly pay rate, or maximize their own net takeout from all sources including their own labor and time, cash return and profit. And lots of permutations thereof!

    In contracting, it is always amazing how many real costs a bidder will “forget” to account for in their bids. Wage burden, employee benefits, interest on funds financing the project, labor time setting up and closing down the worksite each day (on the clock of course), overhead costs which should be allocated to this particular project and other direct and indirect costs. No wonder “apples to apples” bids can be 40% difference between them! Usually, the low bidder forgot a lot, instead of the higher one being greedy.

    So, it is WORSE with real estate entrepreneurs, because so many of them are part-time, relative amateurs. A pro recognizes ALL costs, even if they are not writing checks for them every month (think vacancy and Capex expense allowances), and doing so, makes it a lot more difficult to find a “good deal” which passes muster in a pro-forma analysis. An amateur, leaving out 30% worth of expenses, will pay a lot more for a property due to their apparent cash flow result, which of course, is likely to be a phantom once the chickens come home to roost! Frustrating for pro buyers, who lose deals to amateurs who outbid them, just as it is to pro contractors who lose bids to idiot underbidding contractors.

    All that said, I want to add that I have never seen a turnkey deal with a real ROI of 8.5%. I see a lot of TALK about them, but as I mentioned above, probably not real or true if properly accounted for and burdened with all of the proper expense allowances. An owner could be cruising along for years without having to make impending major CapEx replacements, and feel rich. But unless they sell it before they occur, a reckoning will occur, and if back-accounting were performed, they would not feel so rich after all. And might find a 2% ROI was realized over time. No big deal if it is a long-term rental, but otherwise pretty deflating. Their high return was a mirage, a loan, until the CapeX gods demanded their dues.

    • Ali Boone

      Great info, Rob! All good considerations and good clarity on use of terms and reality and such. I think the turnkey returns could surely be debatable- not that you are wrong in that but that it will just vary between investors and their properties and how they time everything out. My turnkeys have all doubled and tripled in value since I bought them (I bought at an optimal time), so that alone has me covered for just about any CapEx, and then I’ve gotten great cash flow on them in addition. So it will certainly vary with different factors.

      Thanks for sharing!

  2. Charles Borrelli

    Another great BiggerPockets article. I will add that a good rehabber can gain a lot more then 20% equity on a BRRR project or a flip. For me 35-65% is not unusual. This helps generate greater cash flow and helps to prevent loss of the property during market dips but I do love rehab projects as it is my passion. Like the Author I also quit a full time career for this and never looked back.

    borrellihomesllc.com

  3. John Murray

    The big difference between and employee’s way of thinking and an entrepreneur’s way of thinking is work. An employee works for money and an entrepreneur works for freedom. Money is what the employee holds as supreme and they build their own prison. Freedom is what the entrepreneur hold supreme and build their own success. I eat when I want, workout when I want, I invest when I want and work when I want. When work, investment and freedom blur into a lifestyle of success and happiness there are no frustrations or deadlines. Very few will ever know what I’m even discussing here, most are to busy crunching numbers, counting money and dreaming their plans.

  4. Dave Rav

    I have had this conversation with my FIRE small group. Most of them do not invest in RE, although 1 just started and another I think is a money partner (private lender, maybe).

    We talk about returns on our full investment on RE and paper investments (the part of your article talking about *expending either money or physical/mental work*). One very nice trade off in talking RE, is you have much greater CONTROL over the asset. In some ways (some) this can translate into controlling your return. You can decide what renovations will bring you the greatest bang for buck, you decide sale price, rental rate, etc. A creative investor can also find ways to maximize revenue on an existing property (I personally have done this through small upgrades to a property, adding bedrooms, etc).

    One last thing, you talk about your principle investment. What if I used business lines of credit, or a no-money down strategy? What are my returns then, since I used none of MY OWN principle cash? Some would say infinite. I have done this. So, when folks who invest in paper assets want to compare ROI, I always bring this up. Infinite returns always beat 12-15% in the market! For the record, nothing against the stock market. I personally invest here as well. Our household has a total of three 401k’s.

  5. Frank Mooradian

    I’m VERY early in this journey, but it looks like I’d prefer a strategy that splits your example in half. I’d like to BRRRR something, but then have a property manager so that there’s minimal work after the Rehab. I’m really looking for freedom to pursue some artistic stuff that I cultivated throughout my 20’s, & to support a family. I’m entering the tech industry for starting capital involving trading FOREX & my first rental property, probably a multi-family house hack. I’d really like to get to taking home 100K a year with the most free time possible, & then continue to build from there.

  6. John Teachout

    We treat our real estate strategy as “work”. We buy distressed sfr properties and fix them up. Just the two of us (wife and I). We get them fixed up, rented out and do the landlord side of it too. We usually are working on one property and have another one waiting for us. It’s a slow process but we’ve been able to make progress with minimal leveraging. It’s a full time job but we set our own hours, take off days when we want and enjoy being our own boss. We were thrust into this “career” rather abruptly but don’t want to go back to the W2 world. In a few months when we get the next property rented, we will have crested the long uphill climb and start down the other side. So maybe we’ll be able to have meat with our beans and rice, rice and beans. It’s been a good ride and I enjoy learning and sharing about the real estate world.

    • Rob Cook

      John.

      I loved your comment. My wife and I have done the same thing, off and on for periods over the last 40 years. We retired 20 years ago, and in the last 9 years have bought around 30 rental units. We do all of the work on them ourselves, including rehab, repairs, maintenance and on half of them, property management too. So keep at it, you will be laughing about the beans and rice someday, I assure you. This can be a lifestyle business, as it has been for us, and appears to be with you. Lifestyle does not have to mean sitting on a beach 365 days a year with a drink with an umbrella in it. It means you do what you want to do when you want to do it, and for us, that often means getting our hands dirty! We like it, and we are almost 60. And we have over $7 Million net worth mostly due to real estate investing activities, all hands on.

  7. Chris Campbell

    Great article! Could not agree more with the differences between investing in real estate and working in real estate. I have done both and they each can be very successful strategies, but like in all things it is all about what you want out of it and what your goals are!

  8. Vaughn K.

    I agree 100% about the work versus investment thing. Here is the main thing to consider though:

    In your example you lay out $20K in extra equity off the bat, and essentially that is the real difference. You quote this at 60 hours. I would say for most people $333.33 an HOUR is usually going to be worth it! That’s the equivalent of an over $600K a year job, which most people don’t have. That is worth most people’s time FOR SURE… At least until they have $10 million in the bank. Obviously some remodels would take lots more time than that (hence less hourly theoretical wage for their work portion of the deal), some maybe even less if you already know contractors etc and it’s a simple job… At the end of the day comparing it to the time it takes you, and opportunity lost to be doing something else is where it’s at.

    This is why so many people seem to love flipping. It’s easy to make a “wage” that is VERY high by putting a little capital to work along with some deal making skills and work. By combining capital and work in an intelligent way you can really max out the profits in a way you just really can’t do with “pure” investing in any form.

    • Dave Rav

      Breaking it down to a per hourly rate is an awesome way to draw comparisons.

      I often use this method when sizing up contractors’ bids. I look at the time it takes, in conjunction with the level of skill needed. As long as it isn’t super specialized, like foundation stuff, central electrical wiring (no peripheral stuff) or true engineering issues I like to calculate what I’m paying someone per hour. And I realize they have to cover their overhead, I get it, but if some general carpentry stuff is costing me $80/hr (and its for like one contractor + helper) your darn right I’m questioning why!!

    • Ali Boone

      I totally agree, V, and I think the best thing someone can do is break it down to the hourly rate…which you did. I totally pulled those numbers out of my forehead so didn’t even know what the hourly rate would be when calculated out. For many, that $333/hr may be totally worth it, and justifiably so. Maybe in some other cases it’s not that high. Or in some cases (like mine) there’s no price tag on sanity (haha). So it’s all situational and dependent on each investor individually, but I think your breaking it down is an absolutely perfect step for anyone to take in order to start analyzing and seeing what they are looking at. Thanks for sharing!

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