Passive Investing: Comparing Real Estate Strategies
Updated: Dec 22, 2021
For the average working professional, real estate investing provides the best path to generate additional income and wealth for their family. However, true wealth comes with the ability to leverage time and to stop trading hours for dollars. That is why passive investing for real estate is such a key driver for the wealthiest people on the planet. It is said that 90% of the richest people in the world hold a portion of their portfolio in real estate. In fact, Kanye West was just added to Forbes annual list of billionaires with an estimated $81 million in real estate - nearly as much as he made from music and publishing at $90 million.
Kanye and other wealthy people are not real estate experts, but get all the advantages of owning real estate. Being rich doesn’t have to be your goal either. In fact, most people are just looking to generate extra money to cover retirement, a special vacation, an emergency fund, send a kid to college, or give a loved one a head start. These hard workers and busy professionals don’t have to be rich OR real estate experts to get all of the advantages that come with real estate investing. In fact, people can invest passively, just like most of the names on the annual Forbes list using various strategies.
Let’s compare strategies for passive investing and some of the key benefits of passive investing in real estate. In addition, we'll review best practices to evaluate passive investing opportunities.
Passive Investing: Real Estate vs. Stocks
There are many advantages that real estate holds over stocks and other investment types. The primary benefits include stronger returns, more control, and excellent tax provisions.
Real estate delivers strong returns through cash flow and appreciation. Cash flow is all of the property’s income, minus all of the expenses. Appreciation is what a property will be worth minus the cost to purchase and renovate the property. Historically speaking, these returns edge out the stock market. Furthermore, all key data points indicate that more people will be renting in the near future, which will increase demand for rental properties. In fact, WeAreApartments.org estimates that America will need 4.6 million more apartments by 2030.
America will need 4.6 million more apartments by 2030.
One of the reasons real estate is able to beat stocks consistently is due to the control that a real estate investor has over the investment. Unlike stocks, where you don’t get to make any decisions on product launches, personnel hires or other factors that can determine profits, you get to make all the key decisions in real estate. This control allows you to identify opportunities and implement a business plan to boost returns.
The last major advantage is through tax benefits. In the U.S., tax benefits are provided to encourage investment and redevelopment in housing and jobs so the government rewards those who provide these services. Real estate investors are incentivized through various tax provisions, including depreciation, which allows investors to write-off a portion of the property’s value. From a tax purpose, real estate properties depreciate in value each year as their components age, even though properties tend to appreciate in reality. More advanced tax strategies include bonus depreciation and cost segregation. They allow investors to take future depreciation all at one time to net a substantial “paper loss” on the investment, even though they actually MADE money through the rental income. Paper losses can be used against other passive income or any income earned for full-time real estate professionals if they exceed the profit from the property.
Paper losses can be used against other passive income or any income earned for full-time real estate professionals.
As a quick example, in the chart below you see two depreciation schedules on a $2MM property.
The blue line uses a standard schedule of $72,720 each full year for 27.5 years. The green bars use the accelerated depreciation schedule with $348,813 in Year 1 expenses. In this case, you are looking at over $275,000 that can be used in the first year to offset other gains and put back in your pocket! You will need to consult with a tax professional to understand your unique situation, but many of our investors view this as a major benefit. Keep in mind this is not a legal loophole, but an incentive to encourage investment and redevelopment of commercial real estate.
Related: How Cost Segregation Can Lower Your Taxes with Yonah Weiss
Passive Investing Benefits over Active Investing
So how does an everyday working professional take advantage of these benefits?
There are two types of real estate investing: active and passive. Active investing is all the steps that go into finding, acquiring, managing, and operating a real estate property. Passive investing is when you place your capital into a real estate deal but are not involved in the day to day decisions. Forms of passive investing include syndications, REITS, and private loans.
There are two main benefits of choosing to invest passively. The first is the low time commitment. Some people refer to this investment strategy as mailbox money because it just shows up and you don’t have to do any more active work once you are invested in the deal. For busy professionals who have demanding jobs, family priorities, or other passions they prefer to pursue, this is a critical reason to invest in real estate passively. Many of the investors we partner with would rather spend their time doing the things they love, with the people they love, instead of spending that time being a landlord, amateur maintenance tech, OR reluctant arbitrator.
The second benefit is the ability to leverage the deal flow, teams, and expertise of a more experienced investor. Even if you have the time to be more hands-on, it takes time to find good deals and a novice investor may find themselves struggling to find good investment opportunities. In addition, identifying team members such as contractors, property managers, CPAs, and others is time-consuming. And while books and podcasts contain great information, most of the real learning comes from experience. A mistake can be costly and most find it easier to learn through passive investing, which allows you to better understand the decision-making, business plan, and even the due diligence process. Starting out with a more experienced team is a great way to earn while you learn.
Comparing REITs vs. Syndications vs. Private Loans
What type of passive investment is right for you? This is going to depend on your goals, risk tolerance, and liquidity needs. REITs are Real Estate Investment Trusts that are publicly traded on the stock exchange. They are easy to find, have low minimums, and are fairly liquid investments. As a fund, REITs invest in multiple projects so you won’t be able to review specific properties. Since they are traded on the stock exchange, you have no control over what they invest in, personnel, or their business plan.
Private loans allow you to review the property and business plan before moving forward. These are often associated with fix and flip projects and project high returns with 6-12 month hold periods. You will need to find and vet borrowers, along with the deal to determine viability. Due to the nature of the projects, private loans come with more risk. They also provide no tax benefits.
Syndications pool investors together to acquire a property. Of the investors, some are active, overseeing the day to day operations, while others are passive and receive distributions based on the property’s performance. Syndications allow passive investors to get the cash flow and tax benefits of owning real estate, without the headaches of being a landlord. Syndications have direct ownership and allow investors to review each deal, team, and business plan before moving forward. Typically, these deals are held for 3-7 years so they are not as liquid as REITs or private notes. Through advanced strategies, the tax benefits are ideal for anyone with passive income gains (through stocks or business partnerships), as well as qualified real estate professionals. These are private offerings, so you will need to seek out operators and get added to their private investment list.
Related: How to Evaluate Real Estate Syndications
Selecting the right passive investing path will come down to your goals and preferences, but the perks of investing in real estate should be in consideration. Casmon Capital Group focuses on multifamily syndications that deliver strong cashflow, tax benefits, and upside potential for passive investors. These opportunities will allow you to leverage our time and experience to collect the benefits of owning real estate, without the hassles of becoming a landlord.
If you would like to learn more about passive investing in syndications, be sure to access our sample deal. You will also join our mailing list to get key investing insights and access to exclusive opportunities. And be sure to check out our frequently asked questions page to learn more about partnering with us. As a bonus, check out a clip we did with Elisa Zhang on some of the most common questions passive investors ask when reviewing an apartment syndication.