What is Passive Real Estate Investing

35% of Americans state that real estate is their most favored long-term investment strategy, compared with stocks (21%), CDs and savings accounts (17%), and gold (16%).

However, when considering real estate investing, we often think of flipping houses, short-term rentals, and the BRRRR method. Not everyone wants to put that much effort into an investment, and that’s when passive real estate investing strategies come in handy.

Passive real estate investing can be an incredibly effective way to make your money work for you and requires little effort on your part.

In this post, we’ll discuss:

What passive real estate investing is, and how it differs from active investing
The pros and cons of passive real estate investing
Types of passive real estate investments
How to get started as a passive real estate investor

Let’s get started.

What is Passive Real Estate Investing?

A passive real estate investment is an investment that you’re not directly managing. It’s pretty similar to investing in the stock market, except your gains are often more consistent. All you have to do is make a capital investment in something equity-based, like mutual funds, real estate partnerships, or real estate investment trusts (REITs), then enjoy an ownership stake in your investment. From there, a property management company or some other entity does all the heavy lifting, and you’ll receive dividends or other streams of regular income.

Passive vs. active real estate investing

When people talk about investing in real estate, they usually talk about active real estate investments. These are investments in properties you’re moderately or heavily involved in, like house hacking, flipping houses, and self-managed short-term rentals, to name a few. They involve varying degrees of participation in development, construction, rehabbing, and management.

Passive investors don’t have to worry about any of that. You can simply give someone money and have them do the work.

There’s also a third option: active real estate investing and passive management. Here, active investors do the research and buy rental properties, then hire a property management company to do the rest. While this strategy is more passive, it’s not entirely hands-off. You may be responsible for upgrading appliances, making repairs, and taking on other homeownership duties.

How to Get Started as a Passive Real Estate Investor

If you think passive real estate investing is right for you, ask yourself a few simple questions:

Why are you investing?

What are your lifestyle and financial goals, and how does making passive investments help you achieve them? Are you looking to earn regular passive income to cover bills or save for vacations? Are you thinking about retirement or your child’s college fund? Identifying your why will help narrow down an investment strategy.

How much are you investing?

Even though real estate and land ownership are traditionally considered the most reliable investments you can make, no investment is without risk. If we’ve learned anything in the last few years, it’s that life is unpredictable. Never invest more than you can afford to lose.

How hands-on or hands-off will you be?

When investing in real estate, you can be as passive or active as you’d like. Are you looking to invest your money in a mutual fund or REIT and trust your money manager to make savvy decisions? Or do you want to take a more active role in your investment?

Types of Passive Real Estate Investments

Here are the four most common types of passive real estate investments. Each requires varying degrees of effort and financing on your part:

REITs

REITs collectively own more than $3.5 trillion in U.S. real estate assets. You may already own REITs without knowing it because it is estimated that 145 million Americans own them through other investment funds or retirement savings.

With REITs, you can invest in real estate assets by purchasing mutual funds, individual company stocks, or exchange-traded funds (ETFs). Then, you earn a share of the income and/or dividends without buying, selling, or managing properties.

Equity crowdfunding

With equity crowdfunding, passive real estate investors can diversify their investments by owning several properties to assume less risk. Equity crowdfunding involves multiple investors pooling their funds to buy an investment property or properties.

You can start equity crowdfunding with very little capital. However, make sure you carefully read your portfolio’s terms and conditions. Some portfolios won’t let you choose which properties you can invest in. Many of these investments are also subject to fees that vary from company to company.

Turnkey

The turnkey strategy is comparable to the traditional buy and hold but requires less work. Turnkey properties are ready for tenants to move in immediately. Many turnkey investment providers will even select a renter for you, so you can start earning passive income when you close the deal. Once you have a property management company, turnkey properties are nearly hands-off.

However, turnkey properties usually require a larger investment on your end. Since the property is already in excellent condition, it will take longer to earn an ROI, and it’ll usually be less.

Remote ownership

Remote ownership gives you more control without actually having to manage a property. Remote owners can find and invest in properties, then hire and oversee a property management company to maintain them.

Investing remotely can be very beneficial because it allows you to invest in high-traffic areas, like popular vacation destinations. This is what many out-of-state investors do. The most important part is to select your property manager carefully. Not only will they be responsible for day-to-day tasks, but they’re usually too far for you to respond to property needs immediately.

Pros and Cons of Passive Real Estate Investing

Passive investment has many benefits and drawbacks. Here are the most common five for each:

Pros

Lower buy-ins: You don’t need a down payment, pay rehab costs, or get a hard money loan. You can invest in REITs or real estate mutual funds by buying a few shares or starting equity crowdfunding. Many real estate crowdfunding opportunities will require a few thousand dollars to buy in, but you can start a portfolio with Fundrise for only $10!
Less time commitment: And less work! Passive real estate investors don’t have to manage their properties or perform the tasks active investors require. Besides spending time researching and selecting real estate investment trusts, crowdfunding opportunities, or mutual funds to invest in, there’s much more required when you passively invest.
No money management: In passive investing, you’re not responsible for ensuring tenants pay rent on time or budget for renovations or repairs. That’s someone else’s responsibility.
Little experience necessary: We strongly recommend understanding the real estate market and how to analyze an investment, but you don’t have to be an expert in real estate to invest in it.
Unique investment opportunities: Most active investors will never get to invest in mansions, high-rises, or other luxurious properties. However, there are crowdfunding opportunities and REITs that make these options available to you.

Cons

Lower profits: House flipping and BRRRR enthusiasts can make much larger returns by taking on more active investment roles. Sometimes, the extra work pays off.
Longer holding periods: If the housing market is in recession or your valuations flatline for months—or years—it can take a while before you make a sizable return.
Less control: As a passive investor, you give others the power to decide on your behalf. Whether they’re real estate fund managers or property managers, you have to hope these decision-makers make the right choices.
Little experience gained: When actively investing in real estate, you gain hands-on experience as a landlord, business owner, market strategist, and so much more. Passive investors don’t learn nearly as much because they’re not doing most (or any) of the work.
Risk of high tax burdens: Real estate investments in REITs are often taxed higher than other forms of taxable income, like qualified dividends or long-term capital gains. According to REIT.com, “The majority of REIT dividends are taxed as ordinary income up to the maximum rate of 37%.” However, taxpayers can deduct some of it as qualified business income.

Conclusion

As you probably have gathered, passive real estate investing requires a fraction of active investors’ effort. However, that doesn’t mean you’re totally off the hook. Before making any financial decision, you should first do your research.

Luckily, you have no shortage of podcasts, articles, and other content at your disposal at BiggerPockets. Plus, a community of real estate experts to ask questions to in our forums.

Are you ready to become a passive real estate investor?

FAQs

If you have questions about passive real estate investing, address them before you do anything else. Clearing the air improves the odds of making informed decisions that yield the desired result.

Here are several of the most common questions about making a passive real estate investment:

What’s the risk of passive real estate investing?

Passive real estate investing, though potentially lucrative, carries inherent risks.

Market downturns can lead to property devaluation, affecting investment returns. But that’s just one risk of a passive real estate investment. Others include:

Tenant-related issues, such as non-payment and vacancies.
Economic decline that impacts property value.
Unforeseen maintenance expenses.
Changes in tax laws.

Planning for these risks upfront allows you to minimize the potential impact.

How much can you make?

Earnings from passive real estate vary widely based on factors such as property location, market conditions, rental income, and appreciation rates.

On average, investors can expect a 2%-5% annual return from rental income, while property appreciation may provide an additional 3%-5% annually. But remember, these figures are subject to change and will significantly differ from one investment to the next.

Can passive real estate losses offset capital gains?

While it’s best to consult a tax professional regarding your situation, the short answer is yes. Passive real estate losses can offset capital gains. More specifically, losses from rental properties, often termed “passive activity losses,” can offset passive income, including capital gains from the sale of passive investments.

Your tax professional can explain any IRS rules and/or limitations that apply to your investment strategies.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.