Active real estate investing is a great way to build wealth and financial freedom.
In this article, we discuss what active real estate investing is, the pros and cons of being an active investor in commercial real estate, and how to start your journey.
If you’re ready to take charge of your financial future through active commercial real estate investing, read on!
Table of Contents
What is active real estate investing?
Active real estate investing is the process of buying, managing, and selling properties to generate a return on investment.
Active investors purchase property to generate income by building new developments, renovating existing buildings, and maximizing revenue.
Active investors are involved at every stage of the investment lifecycle: from researching a market and screening deals to ongoing management and maintenance.
How do active real estate investors make money?
Active real estate investors generate income by building or acquiring properties, renting them to tenants, and selling them for a profit.
This can be done in various ways: from the ground-up development of multifamily apartments to purchasing strip malls and increasing rents to acquiring old grocery stores and renovating them into self-storage facilities.
In addition to earning cash flow and profit, active investors who qualify as real estate professionals can also benefit from substantial commercial real estate tax benefits that are not available to other types of investors.
What is the difference between active and passive real estate investing?
Active investing is a hands-on process that involves actively finding, acquiring, managing, and selling properties.
Passive real estate investing is when an individual invests money into passive real estate investments in exchange for a return. The passive investor is hands-off in the process and lets the active investors or asset managers take care of everything.
Learn more about the difference between active and passive real estate investors.
How do you qualify as an active real estate investor?
Generally, you’re considered an active real estate investor if you participate in the decision-making process for a real estate investment.
For example, in the eyes of the IRS, someone who owns one or two residential rental properties can qualify as an active investor. As an active investor, you can deduct reasonable expenses from the passive income generated from those properties.
However, note that your eligibility to apply deductions as an active investor fade once your adjusted gross income surpasses $100,000. If an individual earns more than $150,000 in adjusted gross income yearly, they cannot claim any deductions from their active real estate earnings.
When this happens, earning the real estate professional classification is beneficial.
What is a Real Estate Professional?
Aside from categorizing real estate investors as Active and Passive Investors, the IRS has a third classification called Real Estate Professionals.
When you qualify as a real estate professional, you can deduct 100% of all real estate losses (real and paper) from ordinary income instead of just passive earnings like those who fall under the passive or active investor classifications.
There is no limit to the deductions you can take, meaning Real Estate Professionals can eliminate their entire active and passive income tax liability annually.
Even if a complete offset isn’t possible in a particular year, it’s still likely you can significantly reduce your taxes.
There are a couple of ways to pursue this:
1) If you are a high-income earner and your partner does not work, you could acquire rental property and your partner could manage the property to claim the real estate professional status. For example, let’s say you make $275,000 yearly as a doctor; with depreciation costs and other deductions from your rental portfolio added up, you could easily experience around $50K in yearly losses. If your partner manages your properties and qualifies as a real estate professional, the $50,000 of losses can reduce your modified adjusted gross income to $225,000. As a result of this deduction, you could save approximately $10,000 on taxes for the year.
2) If investing in real estate is your full-time job and rental income is your primary income source, you can likely qualify for the real estate professional status and deduct all losses from your income. This is the primary way investors reduce their tax burden to 0%.
Pros and Cons of Active Real Estate Investing
All types of investing have pros and cons. It’s up to you to decide what benefits are most valuable and what risks you’re willing to take to achieve them. Here are five benefits and five risks of active investing.
5 Pros of Active Real Estate Investing
1. Potentially Higher Returns. An active investor can generate outsized returns compared to a passive investor. The reason is that a passive investor often receives a pre-determined return on their investment, whereas active investors have more opportunity to capture more of the upside after a successful exit.
2. More Control. The crux of being an active investor is participating in the decision-making process for real estate investments. Naturally, this leads to having more control over the investment strategy and the asset itself.
3. Tax Savings. If you are an active investor as your full-time job, you can gain the real estate professional status and deduct 100% of the real estate losses from your ordinary income. This can lead to massive tax savings.
4. Hands-on Work in the Real Estate Industry. If you’re interested in real estate, you’ll likely enjoy staying updated with market trends, challenges, and opportunities. As an active investor, you can surround yourself with the industry and become even more knowledgeable.
5. Work Flexibility. One of the greatest benefits of active investing is that you can often do it from anywhere. You don’t have to live in the market you invest in, and if you invest in NNN properties or hire a management company to operate your properties, you can likely make your own schedule and live life on your terms.
5 Cons of Active Real Estate Investing
As mentioned, benefits don’t come without risks. Let’s look at the cons and risks of active investing in commercial real estate.
1. Higher barrier to entry. Commercial real estate is a competitive space. Getting involved as an active investor requires more energy and effort than logging onto your brokerage account and purchasing a few shares of a real estate ETF.
2. More Work. As an active investor in real estate, you’re responsible for managing the properties you acquire, and property management will make or break your deals long-term. Even if you hire a property manager, you’re still responsible for managing them and ensuring they’re properly renting properties, collecting rent payments, addressing maintenance requests, etc.
3. Substantial Financial Responsibility. Commercial real estate isn’t cheap. As an active investor, you must work with passive real estate investors and lenders to fund deals. When a property is acquired, you’re the one responsible for repaying the investors and lenders.
4. Potential for Bigger Losses. Not all investments go according to plan. If an unpredicted circumstance derails your deal, you could experience higher losses than if you were invested in a deal passively.
5. Delayed Return on Investment. To ensure the lenders, silent partners, and investors receive their returns and remain happy with you, you may delay some or all of your returns until a rental property is sold or refinanced. This could mean you go a long time without reaping your work’s rewards.
What are the Best Ways to Start with Active Real Estate Investments?
There are three ways to start with your first real estate investment as an active investor.
1. Work with a Mentor
Working with an experienced mentor is a great way to start your active investing career. A mentor can provide invaluable insight into the market you are interested in, guide you through property acquisition, and help you understand the ins and outs of commercial real estate investing. Mentors can also be beneficial in helping you network with brokers, lenders, and other investors.
2. Provide Value to an Established Team
Providing value to an established real estate investing team is a great way to jumpstart your investing career. By taking on additional tasks that the team doesn’t have time for or doesn’t know how to do, you can add a valuable asset to the team in exchange for equity in a real estate deal.
3. Tap into Your Local Market
Networking in your local area is an invaluable way to build your real estate portfolio. You can find potential investments and gain access to valuable resources and expertise from experienced investors who know the local market inside and out. By building relationships with others in the industry, you can learn the details of real estate investing and how to evaluate potential investments.
Active real estate investing is a great way for individuals to generate outsized returns and substantial long-term wealth. It requires a lot of effort and focus, but pursuing this path can make it possible to build a portfolio of passive investments that generates passive rental income to sustain you for the rest of your life.