Active vs. Passive investing: which one is a better fit for you?December 16, 2019
Real estate is a popular investment choice because it is an excellent way to diversify and strengthen just about any investment portfolio. It has the potential to provide investors with an attractive total return, tax advantages, and the opportunity to invest in a tangible asset. There are essentially two roads to real estate investments: active and passive. Both offer varying degrees of risk and require different levels of investor participation, real estate investing proficiency and investible capital.
If you’re hands-on, have the time, energy, knowledge and skills to effectively take care of all aspects of your real estate investments, active investing might be the right ticket for you. If you don’t want to research properties, negotiate price, or have any interest in doing the daily operational duties of property management, passive investment strategies would certainly be a better fit. Let’s take a closer look at both options.
ACTIVE REAL ESTATE INVESTING
For the most part, active investing is best suited for experienced real estate investors who desire complete control over their investment. What this means is that you’re the boss. You’re required to take part in all aspects of the deal, from finding the property, performing detailed pre-purchase due diligence, obtaining favourable financing, to dealing with your tenants and property maintenance issues.
If you’re considering active real estate investing, here are a few points to remember:
You’re taking on higher risk
Because you are putting up all the equity for the investment yourself, it takes more money to get started as an active investor. Active real estate investing involves taking on more risk, as you will be the only one who takes a hit for any losses that occur.
So, you better make sure that before you buy any commercial property, you have an extensive due diligence process for evaluating the current condition of the building and ascertaining your immediate and future capital expenditure requirements.
What’s more, as a sole investor, you’d be limited to the number of properties you could purchase on your own, limiting your ability to diversify and spread the risk across a portfolio.
It is up to you to find a property
Just finding a property to purchase will require a substantial amount of time and energy. Not only will you have to identify properties within your general price range, you will have to perform an in-depth physical inspection of the property, collect competitive market rent data, and build a 10-year present-value forecasting model in order to arrive at a fact-based price for the property.
Limitations to types of properties
Using your own financing means you are limited as to the type of property you can purchase. You may only be able to purchase small-scale properties, preventing you from investing in larger properties with attractive returns, such as apartment buildings.
You’re responsible for securing financing
Finding the capital could mean dipping into your personal savings or using your home as collateral, making it stressful for you and/or your family. You will also be responsible for securing the mortgage on the property. Finding appropriate financing could be a time-consuming process given the nature of the reports and documentation that lenders will require before they will loan on a commercial property.
Higher time commitment
Congratulations! By getting into the real estate business as an active investor, you’re officially a landlord. This is a huge endeavor as you are now in charge of property management, building maintenance and legal compliance. And when something unexpected occurs, you’re responsible for making those decisions, which can come with a lot of stress and headaches.
PASSIVE REAL ESTATE INVESTING
A passive, or indirect, investment is ideal for someone who wants to invest in real estate, but does not have the interest, time or expertise to purchase and actively manage it. You still have the benefits of actual ownership, but without the obligations and risks associated with active ownership.
Let’s look at what it means to be a passive real estate investor.
No effort involved
Once you find the right investment vehicle that matches your financial objectives, you just invest your capital, sit back and let the professionals do the work for you. All that’s left to do is cash your dividend cheques or reinvest them in order to reap the benefits of dividend compounding. What’s important to note here is that this type of investing is effortless.
You don’t have to find the properties to invest in
With passive investing, you are plugging into an already created and proven acquisition process run by an experienced team of real estate professionals who locate and analyze hundreds of deals a year to uncover the best deals.
Your overall risk is lower
You are exposed to much less risk as a passive investor. Since all aspects of the investment process will be managed by experienced real estate professionals, it is more likely that your profit will be maximized, as the risk of making financial errors in overpaying or underpricing rental prices will be minimized.
Being part of a pooled real estate fund, which owns numerous properties, means your real estate portfolio is diversified, which significantly helps reduce the risk associated with it.
Access to a wider range of properties
By pooling your funds with other investors, you’ll have access to more institutional-grade properties, which can translate into higher returns when compared to significantly smaller property types that active investors can handle on their own.
Real estate investing can be for everyone: however, not all investment strategies are the same. For some, actively participating in their investments is important to them, while others prefer to kick back and let seasoned real estate professionals do the work for them. It’s important to understand what’s involved with each to determine which strategy best suits your financial goals and lifestyle.