Investing in Real Estate can be approached in two ways, actively or passively. When actively investing in Real Estate you assume the position of landlord and sometimes property manager. Passive investing does not include nearly the same responsibility or time obligations. Passive investing can be done through partnerships or REITs.
Active Real Estate Investing
Active Real Estate investing takes much more time and can be a career in itself. With the extra time and effort can come great rewards; active real estate investing can often create larger returns on your capital than passive investing. People can either do active investing by developing land, flipping properties, or renting out property. Sometimes, a combination of these is even applied.
By taking an active role, an investor does have the opportunity to improve the property and therefore raising its value and sell for a larger profit. With a passive investment, you are not in control of the property so therefore must depend on those who are managing the property. As an active investor you also have control over which properties you will buy and manage.
The disadvantages to active investing are of course the amount of time and expertise it takes. You are also limited in terms of diversifying your portfolio or taking on large property developments based on the amount of funds you have to spend on investing.
Passive Real Estate Investing
Passive Real Estate investing can be taken on in a number of ways, including partnerships and REITs
- Limited Partnership
This was a very popular investment vehicle for passive investing throughout the 1970s and 80s.
- LLCs and LLPS
Limited liability Companies and Partnerships are a fairly recent creation in most states.
A Real Estate Investment Trust is a corporation with a special tax designation which allows the REIT to avoid paying federal income tax on dividends distributed to shareholders. Many REITs are publicly traded on major exchanges such as the New York Stock Exchange (NYSE).
With passive investments, the investor avoids the headaches and time associated with active real estate investing. Property management is taken care of by the partnership or corporation. This frees up the investors time, which is why it is called passive income. The disadvantage to not being actively involved in the ownership and management of the property is the passive investor does not have the opportunity to directly make improvements to the property to increase its value. Therefore, passive investments may potentially not be as profitable as active real estate investing.
In addition to freeing up time, passive real estate investing also allows the investor more opportunity to diversify their investment portfolio and spread the risk. With direct investing, the average investor cannot afford to invest in a large number or types of properties. With passive investing this is possible.
Another potential benefit to passive investing is that some forms of investments offer liquidity. REITs for example, are traded on major stock exchanges which makes buying and selling shares possible. Real estate itself is an illiquid asset and cannot always be easily sold for cash.