Investing in commercial real estate can be an excellent way to build your wealth—and with passive real estate investing, it’s even easier.
This article covers the fundamentals of passive real estate investing to help you get started. We look at different types of investments you can explore as a passive real estate investor, along with questions to ask yourself before you start and more.
Whether you’re an experienced investor or new to passive real estate income, read on to learn how passive real estate investing could be a great choice for you.
Table of Contents
What Is Passive Real Estate Investing?
Passive real estate investing is when you give a professional real estate investor money for them to invest in real estate assets. The active real estate investor does all the work regarding finding, improving, stabilizing, managing, and selling the asset, and shares a portion of the cash flow or profits with you in return for you investing your money.
A passive real estate portfolio or investment requires little work from passive investors because they generate an income stream from real estate holdings without actively managing them. The goal of this investing style is to still reap the benefits of real estate – like steady cash flow and potential property appreciation – without giving up much time or energy.
The Two Types of Passive Real Estate Investing
There are two passive real estate investing types: Truly Passive and Active Real Estate Investing with Passive Management.
Truly Passive is a hands-off approach where investors pick assets, provide funds, collect checks, and carry on with their lives.
Active real estate investing with passive management is a more hands-on approach for investors who still want to do little work but don’t want to give up control of their investments. In this type of investment, investors acquire rental properties and then hire a property management company to manage the day-to-day operations. While this is a mostly passive approach, the investor must occasionally be actively involved and conduct manual work, such as managing the property manager or property management company.
This article focuses on the first approach since it is the truest way to collect real estate passive income. Explore our active investing resources if you’re interested in active real estate investing with passive management.
Pros & Cons of Passive Real Estate Investing
Here are the main pros and cons you should consider as you conduct your due diligence.
Top 10 Pros of Passive Real Estate Investing
There are many benefits to investing in real estate passively. Here are ten pros to consider:
Lower barrier to entry. Passively investing in real estate offers a lower entry barrier than active real estate investing as it typically requires less financial capital, knowledge, and resources to begin.
Less time and work. Investing in real estate passively requires significantly less time and work than active real estate investing because passive investors only provide capital for active investors to use to fund the real estate deal. The active investors do all the work regarding finding, improving, stabilizing, managing, and selling the asset.
Truly passive income. Passively investing in real estate generates truly passive income, allowing you to reap the benefits of active real estate investments without taking on the time-consuming work of actively managing the property, such as finding and improving assets, stabilizing cash flows, and handling property management.
Shorter time commitment and better liquidity. Most passive investment vehicles offer better liquidity and shorter time commitments than active real estate investments. For example, if you invest in a real estate ETF, you don’t have a minimum holding period and can usually enter or exit a position within 24 hours.
Accessible portfolio diversification. Adding real estate to your investment allocation can help you mitigate your risk by investing in multiple types of commercial real estate. Passive investments like crowdfunding and mutual funds can help you invest in multiple assets with less upfront cost while still receiving passive income and potential property appreciation.
Hedge against inflation. If you invest in passive real estate vehicles, you can gain a unique inflation hedge compared to other investments (such as stocks and bonds) because the income and appreciation generated by real estate assets are not tied to stock market fluctuations. Additionally, real estate tends to perform well in inflationary environments because the value of the building often increases with the value of inflation.
Less liability. Passive real estate investors have limited liability due to their lack of direct involvement in the management and operation of the property. The active investors take on the additional liability of actively financing and managing the property.
Access to commercial assets that have historically only been accessible to large institutions. With an increase in passive investment options, individuals can now access properties that used to be only accessible to large institutions or entities, such as institutional investors and banks.
Leverages the expertise of professional investors. As a passive investor, you don’t need to know everything. Instead, you can tap into the expertise of professional investors and benefit from their experience in finding, improving, stabilizing, and managing properties without taking on any additional responsibilities or liabilities yourself.
Less stressful than being an active investor. Actively investing in real estate can be stressful. Investing passively eliminates the need to take on the stress of finding, acquiring, renovating, and managing properties while benefiting from the industry’s upside.
Top 5 Cons of Passive Real Estate Investing
While passive investing can be a great option, it also carries natural risks. Here are five cons you should consider:
Lack of control. Passive real estate investors have less control over their investments than active investors since passive investors aren’t doing the daily work.
More fees. Since passive investors rely on the expertise and work of active investors, they often pay fees to help compensate the active investors for their value. These fees often come in the form of management fees.
Less profitable. Passive investors typically favor consistent cash flow and steady growth over substantial gains. On the other hand, active investors who operate deals often take less consistent cash flow in favor of a bigger payout when the property is refinanced or sold.
Potentially less liquid than other securities. Some passive real estate investments—like syndications or crowdfunding—have a longer lock-up period than other securities like stocks and bonds. This means that you may need to keep your money in the investment for one to seven years before being able to access that capital again.
Lack of diversification. Some passive investments require minimum investments of $50,000 or $100,000. Depending on how much cash you can invest, this could cause you to invest all of your funds into a single property syndication. In this event, you significantly decrease the diversification of your portfolio, which is a tradeoff to consider heavily in your due diligence.
Active Real Estate Investing vs. Passive Real Estate Investing
The difference between completely passive investment and active real estate investing lies in the level of control and involvement passive investors have in their investments.
Active real estate investing requires investors to take on the full responsibilities and liability of actively managing a property. This includes finding, acquiring, renovating, managing a property manager and tenants, handling repairs, managing the operating budget, selling, and communicating with other investors.
Passive real estate investing eliminates the need for passive investors to take on these tasks, allowing them to reap the benefits of truly passive income and property appreciation without needing to stress over daily operations. Learn more about the difference between an active investor and passive investor.
Types of passive real estate investments
As mentioned, passive investing in real estate is a great way to enjoy the rewards of passive rental income and rental property growth without needing to actively manage an investment property.
Several types of passive real estate investments are available, each offering different returns and associated risks.
Here are the most common, listed in order of ease of entry to start.
Real Estate ETFs
Real estate ETFs are passively managed and allocate resources to equity REIT securities, derivatives, and related investments. Two indices typically used for real estate ETFs are the MSCI U.S. REIT Index and the Dow Jones U.S. REIT Index; together, they account for almost two-thirds of all publicly listed domestic U.S. real estate owners’ market value!
ETFs provide passive investors with a cost-effective way to access an array of real estate investments. Moreover, these funds offer considerable liquidity—they can easily be purchased or sold within a brokerage account in minutes.
Publicly-Traded Real Estate Investment Trusts (REITs)
Real Estate Investment Trusts (REITs) are a passive real estate investment option that enables you to access the potential returns of a diversified portfolio of income-producing real estate assets without managing them directly.
REITs work by allowing investors to purchase shares in professionally managed trusts. The trusts then purchase and own income-producing properties such as office buildings, apartment buildings, residential real estate (rental properties), and shopping malls. As the trust collects income from its properties, it will pay dividends to all its shareholders consistently.
Real Estate Mutual Funds
A real estate mutual fund can be a great option for investing in public real estate securities, such as REITs.
However, unlike REITs, which primarily generate their value by paying out consistent dividends, real estate mutual funds primarily generate returns through appreciation over time.
One of the big advantages of a real estate mutual fund is the level of professionally-managed diversification you can access. This is because real estate mutual funds are effectively professionally-managed portfolios of REITs and other real estate businesses.
Like a publicly traded REIT, a private REIT owns and operates several properties in its portfolio.
Unlike a publicly traded REIT, where shares are available to the public, a private REIT is not listed on an exchange and its stock offerings are exclusive.
Private REITs are typically available to accredited investors and organizations, such as pension funds and endowments, via private placement offers.
One con to private REITs is that the liquidity for these shares is often substantially lower than with public REITs, and the minimum investment amount is usually much higher.
Real Estate Crowdfunding Platforms
Real Estate Crowdfunding platforms empower passive investors to invest in pre-vetted, rental property investment opportunities with as little as $5,000.
These investments are typically pooled with other passive investors to purchase properties such as office buildings, multi-family homes, or retail spaces.
When you participate in a crowdfunded project, know that your money will likely be tied up longer than in an ETF or REIT. This is because your money is going directly to the active investors, who will then use the money to fund deals.
Real Estate Syndications
Real estate syndications are similar to crowdfunding platforms but are more intimate and can require higher minimum investments but have the potential to yield higher returns.
Active investors—also known as “sponsors” in the syndication space—pool money together from passive investors to acquire larger properties such as apartment complexes or retail centers, which are then managed by the syndication’s management team.
The passive investors in the deal receive an agreed-upon rate of return until the property is refinanced or sold. The passive investors will likely receive their initial capital and additional profit at that point.
Private notes offer a more direct approach for passive investors to enter the commercial real estate field.
If you have liquid cash and know an active investor who needs capital, you can loan them funds by creating and signing a promissory note that states your conditions, such as interest rate and repayment plan.
If the active investor accepts the terms, they can take the loan and uses it to execute their project plan. Afterward, they pay back the passive investor following the terms of the promissory note.
Questions to ask yourself before passive real estate investing
Anytime you want to invest in something new, you should ask yourself key questions to determine if the investment will fit you and your goals.
Here are two questions to ask yourself before starting.
How passive do you want it to be?
Real estate investing can range from highly active to totally passive, and you can decide where your own real estate investment portfolio should be on that spectrum.
Ask yourself: how much work am I willing to perform? Do I strictly want a means of generating passive income, or is there part of me that wants a more active, hands-on approach?
What other investments do you have?
Depending on your level of expertise with a single asset class, the diversification of your total portfolio may be a critical component of your investment strategy.
When making investment decisions, evaluate where else your funds are invested and determine the ideal amount of your portfolio to allocate for real estate.
Ask yourself: what is the asset allocation of my portfolio, and how much of my portfolio do I want to be invested in real estate?
Passive Real Estate Investing FAQs
Here are frequently asked questions about passive investing in commercial real estate.
1) How does passive real estate work?
As a passive investor in real estate, you invest your money into real estate properties or real estate related companies and allow active investors to manage the logistics and performance of the investments themselves. It can be a great investment strategy for those who want exposure to the power of real estate without wanting to do a lot of work.
2) Is real estate good passive income?
Real estate can be a excellent passive income if you research and do your due diligence. This means understanding what investments you’re making, why you’re making them, who’s operating them, and the risks and benefits associated with them.
3) Is passive real estate worth investing in?
Like all investments—it depends. Making a passive real estate investment can be worth it if you want exposure to the real estate industry without doing a lot of work. If you’re okay giving up the control and earning slightly less of a return than you would have as an active investor, then exploring passive investment opportunities is certainly worth your time.
In conclusion, passive real estate investing is a great way for passive investors to access the potential returns of passive real estate income and property appreciation without taking on any day-to-day responsibilities associated with actively managing a property or real estate funds.