Passive vs Active Investing in
Before creating your pool of wealth through investing in real estate, you need to decide whether you want to be a passive investor or an active one. Although you will invest in the same asset, the roles of the two are extremely different.
Here are four factors that one should consider before choosing their path of investing.
The level of control you want decides whether you would want to be a passive investor or an active investor. As a passive investor, you lay back and relax while all the cumbersome tasks of putting your money to use efficiently will be done by an experienced sponsor/syndicator you choose. You are a limited partner in the deal but the returns that you receive are constant. When you give up control you’re putting a lot of trust into the sponsor and their team to execute on the business plan where they entirely manage the commercial real estate project.
The active investor, also called the deal sponsor, has enormous responsibilities to take care of. They are responsible for due diligence for the deal. It is their responsibility to underwrite the project thoroughly to present it for capital investment.
A rigorous search for debt capital is needed by active investors which is in no way similar to smaller real estate projects or single-family.
Lenders perform their own due diligence while lending about 70-80% of the necessary capital for investing. They evaluate the deal and experience as well as expertise of the sponsor before stepping forward.
Experience is the key to be able to become an active investor. The ability to negotiate loan terms with lenders and selecting the type of lender that needs to be approached for heavy value add properties versus stabilized assets is a task in itself. Other than this, many attorneys and supporting staff are also involved in the confirmation of the lending. The process usually takes up to 90 days but if you plan it well it might be as quick as 30-60 days.
Not only this, as an active investor, you directly control the business plan by deciding which investment strategy to pursue. You decide the type and level of renovations to perform. You decide the quality of tenant to accept and the rental rate to charge. You determine when to refinance or sell. With passive investing, all of the above is determined by the syndicator.
Normally from a personality fit someone is either active or passive, but not both, and it usually comes down to whether they want to have control or not.
2. Time Commitment
Managing a real estate project is not easy. It’s a lengthy process. The property demands renovations, maintenance, and improvements. With
great power comes great responsibility which will indeed require time and effort.
Finding the right class asset, finding and vetting various team members (broker, property manager, attorney, accountant, etc). Once this is done, you have to perform all the duties required to find, qualify and close on a deal.
After closing, even though you may have a great team, you will still have to guide them. When something unexpected occurs, you’re responsible for making decisions and fixing the problem. Of course, it is indeed possible to automate the majority, if not all, of the above tasks. But that requires a certain level of expertise and a large time investment to implement effectively.
Passive investing is more or less hassle-free. You don’t have to worry about any of the actions described above. Once you’ve vetted the syndicator/operator and the deal, you simply invest your capital and are kept in the loop with monthly or quarterly project updates all the way up until there’s an exit/sale.
As a passive investor, there is lesser exposure to risk. You will be taking advantage of a pre-created and already proven investment system run by an experienced sponsor who (preferably) has successfully negotiated and
finalized countless deals in the past. Also, returns have more certainty. The projected limited partner returns will be known by you prior to investing, both ongoing and at sale. Also, these projected returns should be exceeded, even working under the assumption that the syndicator conservatively underwrote the deal.
A much riskier strategy would be actively investing. Directly buying properties might leave an investor open to unlimited risk exposure through loan guarantees. However, the higher risk factor results in higher upside potential. The entirety of the deal is owned by you, which means you are the sole recipient of all of the profits, however, the burden of any losses incurred has to be borne by you while investing actively.
4. Deal Flow
Experience matters when it comes to taking control of the deal that you’re looking forward to. Deals do not just fall in someone’s lap, you need to search for them with all the important factors taking into account. Read about those factors here.
In the case of passive investing, all these factors are taken care of by the sponsor. Passive investors outsource the acquisition process to syndicators who uncover quality deals. By owning a share in many properties, passive investors’ fortunes don’t rise and fall with those of any single asset, and they don’t need to answer the phone in the middle of the night when something unexpectedly goes wrong.
What you need to know:
When vetting a sponsor make sure proper due diligence is done so there’s an alignment of interests. Make sure you develop the amount of trust required before making an investment. Speak to the syndicator, go through the reviews, visit their website, and then decide.
Planning to Invest in the near future? Learn more about Passive Investing by joining our Passionate Passive Investors Club.