There are two main options for investing in real estate: active and passive. Lon Welsh is back to break down the differences, give us examples of both types, and lay out some of the pros and cons of each. Check out Episode 1 in our series to learn more about Lon, and why he’s a great guide to understanding real estate investing.
- Listen to the podcast “#388: Active or Passive Investing? Picking a Strategy that Works for You” Denver Real Estate Investing Podcast
- Watch the YouTube video (at the bottom).
- Read the blog post. Note, the blog is an executive summary. Get the in-depth breakdown from the podcast or video.
What Is the Difference Between Active and Passive Real Estate Investing?
The main thing to understand about active real estate investing is that you are in control. You make the main decisions and are responsible for everything.
There’s an educational process required to be a successful active investor. You need to
- Learn the market
- Find a realtor and mortgage broker you trust
- Learn the pro/con of different neighborhoods
- Find the asset and underwrite it
- Make sure the rents are sufficient for cash flow and reserves
- Inspection, arrange financing, and close on the property
- Find a property manager, or do all of the property management yourself—collecting rent, paying bills, etc.
- You need to gather criteria to decide when you want to sell
- Find a realtor and manage the closing process
With passive investing, you give someone money, they do all of the above-described work, and they send you back a check.
What Are Some Different Types of Active Investing?
Lon has run the gamut of active investing and understands the pros and cons of different strategies. These are the most common types, all of which he’s done or is currently doing:
Long Term Rentals
This is what most people tend to think of as a traditional rental property. It’s a house, condo, four unit multifamily, or even an apartment or office building if you can afford it. You hold the property over a long period with tenants in it for a year or so at a time. It doesn’t need to be the most polished property or in the nicest neighborhood to generate solid returns.
Short Term Rentals
Short term rentals are properties are advertised on VRBO or Airbnb, usually in nicer neighborhoods, and need to be kept up really well. Essentially, you’re running a hotel and must provide furniture, sheets, towels, kitchen and equipment for the guests. Pursuing this investing strategy really means you are in the hospitality business. You need to spend time responding to guests and playing the role of concierge. It’s possible to find a property manager to do all of this, but the bottom line is that being available and prompt with responses is a key function of this type of investing.
The big advantage with short term rentals is that the rates of returns are generally much better than long term rentals, so the greater effort and risk are commensurate with the reward.
Fix and Flips
This entails buying a distressed property, fixing it up yourself or finding a general contractor, and selling it for a profit. You can also refinance it and take out cash while using it as a long term rental. Or, you can even rent out part of the property and live in the other part.
While this isn’t an exhaustive list, it covers the widest swath of the active investing world.
What Are the Different Types of Passive Investing?
There are three main buckets of passive real estate investing:
Real Estate Investing Trust (REIT)
This is the most common type of passive real estate investing. Over the past 20 years, the stock market, on average, has annually gone up 8% per year, while REITs have gone up 13%.
You don’t have to be an accredited investor (more on that later), just be able to put cash into the trust. Like the stock market, it’s very liquid. You can take out your money whenever you want.
In a syndication, there’s a lead person responsible for the real estate project, called a general partner, who does all of the work. The majority of the cash for the project comes from limited partners. They write the check but don’t have to guarantee the loan or manage the project. Because they have less responsibility, limited partners get paid less than the general partner.
At the end of the project, everyone gets their capital back in addition to the proration of the profit.
A real estate fund is the type of passive investing Lon’s company Ironton Capital does. Lon invests in eight or ten different projects nationally and diversifies the asset types: apartments, warehouses, hospitality. He is also dividing the investments equally between new development and existing assets with value-add opportunities.
The easiest way to think of a fund is to see Lon as making ten investments into different syndications for you. He’s picking extremely diversified projects so that not all of your money is going into one type of asset. Not every asset will perform the same, so diversifying them is kind of like investing in a mutual fund. Thanks to Lon’s 20 years of experience in real estate investing, he knows which projects to pursue.
Since he’s combining the capital of several hundred investors, he’s investing several million into each project. That allows Ironton Capital to negotiate much better terms than if they were an individual investor putting in a small amount like $100,000. The targeted returns for the current fund are 14-20% per year.
To understand more about this type of investing and Ironton Capital, check out the webinar Lon hosts on a regular basis.
What Are the Pros and Cons to Each Type of Passive Investing?
When you put money into a syndication or fund, you are often committing that money for three to five years. While the general partner will give you an idea of how long that money will be tied up, you won’t know for sure. You typically can’t get the money back before the project is complete.
On the other hand, because you gave up your rights to liquidity, you’re paid more to offset the risk. You’ll see greater returns in a syndication or fund because of this.
In order to be eligible to invest in a syndication or a fund, you usually need to be an accredited investor. This is regulated by the SEC and defined as an individual who makes more than $200K a year, or a married couple who makes more than $300K. You are also eligible if you have more than $1MM to invest, not counting your primary residence.
Most REITs don’t require you to be an accredited investor. The offset is that REITs make less money, and Lon thinks they’ll make even less over the next five years.
Learn More through Our Webinar
Everyone is in a unique situation and has different amounts they can invest. To figure out your next move, check out the Investor Decision Tree in our next episode. It’s a great flowchart that will show you how to make investing decisions.
If you have questions or want to learn more, go to the webinar. It will give you information about the fund, and in the next month will feature an additional version of the decision tree.