by Theresa Bradley-Banta
Should you be an active or passive real estate investor? This is the first and most important question you have to answer.
When I work with my clients I ask:
- How much time and energy do you want to commit to your investments?
- Are you willing to commit to the education required to become an active investor?
If you’re a new real estate investor you must decide if you want to experience the process of investing or turn it entirely over to someone else.
For example, you will have little say in the management, operations and sale of an investment property when you invest in a Real Estate Investment Trust (REIT)—a passive investment. When you invest in someone else’s deal you are usually a passive investor.
When you directly buy an apartment building or single-family rental you are making an active investment. You are the investor in charge of making all decisions that affect the property.
Residential real estate investing can be a tremendously rewarding experience. The financial rewards can be many. And you have an opportunity to positively impact the lives of others by providing a safe and secure place to live.
You can start by making some personal decisions. Ask yourself:
- Do I want to be an active investor?
- Do I have a strong desire to take a leadership role?
- How much control do I want over my investments?
- How much time am I willing to spend?
You must also assess your aversion to risk.
Your first step
Before you make a real estate investment decision, decide whether you want to be an active or passive real estate investor. If you haven’t decided on the active/passive question you will have no idea what your investment strategies will be.
If you don’t know which route you want to take, you could become prey to less scrupulous investors looking for money. Lack of education can set you up to jump at every opportunity that presents itself. Or you can easily become discouraged.
In real estate the more active leadership role an investor takes, the better their returns. And it’s more fun. Note, when you invest in education then you are in a place to play in bigger deals and take an active rather than passive role.
Can you be both an active and passive real estate investor?
The short answer is yes.
A good strategic mix of both passive and active investments can pay dividends for many years to come. A mix can also put less demand on you in terms of personal time and energy spent managing those assets.
I work with people at all levels—from the new investor buying a first real estate investment property such as a single-family rental or a duplex to investors who want to jump straight into a larger property such as an apartment building.
Both are great strategies. Investment real estate can be leveraged over time into larger properties or by taking the profits and reinvesting into other asset classes.
I also work with investors who start their investment career as a partner in other investor’s deals. They start by taking a passive role. It’s a great way to learn the ropes from the inside.
What are the benefits of active vs. passive investing?
With direct ownership an active investor has a greater opportunity to build wealth when done with the proper education. And with education comes the courage to take bigger steps and to move into a more active role in real estate investing.
A benefit of passive investments, such as a REIT, is that you can invest in asset classes in which you might not otherwise have an opportunity to invest. This might include shopping malls, office buildings and hotels. You are also able to sell your share of the REIT—REIT shares are more liquid than real estate.
With direct investing, where you personally buy and own a property, you often must time the market before executing your exit strategies.
A REIT is a paper asset, an interest in a security—similar to investing in the stock market. You also don’t have the headaches of managing those properties yourself.
It’s all about control and risk.
With a REIT you don’t actually own real estate. You receive dividends and the benefits of appreciation (if any). However you can realize higher returns on property owned by you in the form of cash flow and appreciation, as well as principle pay down and depreciation.
How important is diversification?
Building a solid real estate investment portfolio over many years is a smart strategy.
Most successful investors invest in a variety of asset classes. It’s a good strategy for strengthening your risk profile. It’s possible to diversify within a single investment category. For example real estate offers many assets classes such as single-family real estate, apartment buildings, mobile homes, storage units, retail, etc. Successful investors don’t invest in real estate based on the whim of the day.
The diversification of these assets and the amount that you allocate is a personal decision. But you’ve go to be careful not to diversify for the sake of diversification.
It’s smart not to put all your eggs in one basket but at the same time you do not want to chase 50 small investments and lose control over all of all them just for the sake of having a “diversified” portfolio. It’s to the new investors advantage to carefully invest in assets that give positive returns.