By

on

7 Tried & True Ways You Can Passively Invest In Real Estate

Rock climber holding out his hand

When you typically think about real estate investing, you think about finding a rental, coming up with a downpayment, qualifying for a loan, and then the hard part: fixing the place, finding a tenant, tracking the books, and so much more. It's a lot!

That's how we got started. We bought a duplex after spending 18 months looking for the perfect deal. Then, just as we moved in, the tenants on the other side gave us their 30-day notice. So, we lived out of the garage - in November (my wife really likes me) - while we fixed our side. Then we jumped over to the non-fixed-up side.

And that was all before collecting a single month's rent.

That is actively investing in real estate, where you're adding sweat equity into the deal. It takes a lot of focus and requires business sense and tenant-landlord knowledge. This is especially true if you're investing to make money *today*. I often hear, "It's part of my retirement plan. I'm breaking even today, but in 20 years, my mortgage will be paid off, and then I'll have cash flow." Maybe. But I have a hunch that if they ran a discounted cash flow analysis (which factors for time), they would have been better investing in something else.

So, you like the idea of investing in real estate but can't commit to the time and knowledge to do it well. What options exist?

Passive Investment Options

Here's a secret you'll quickly learn at any real estate investment meetup: most real estate investors are broke. Sure, they have enough money to cover their living expenses, and they were able to cobble together enough money for a downpayment at some point. However, 99% of investors are not buying right now because they don't have money to buy another property.

That, again, was me. I had an excellent job at HP, but I could only buy a place every other year. I would go 23 months before I could buy another property. Yet, I would regularly find 1-2 deals a year that I wanted to buy if I only had the funds.

Passive investing is when you provide the funds to someone else who finds, buys, repairs, manages, and eventually sells a property.

And there are multiple ways to structure this, which all have different risk/reward profiles.

1) REITs

This works like the stock market, where you buy a company's share. "To qualify as a REIT, a company must have the bulk of its assets and income connected to real estate investment and must distribute at least 90 percent of its taxable income to shareholders annually in the form of dividends." (SEC)

So you don't directly own any real estate. You own a share of a company with a large real estate portfolio. It's nice because it's as easy as buying and selling a share in the stock market. I just looked up a REIT ETF, and you can start today for only $22.81.

Historically, returns are around 4.3%, but there are no additional tax advantages.

2) Equity Crowdfunding

This is similar to REITs in that you sometimes start with very little money - $10. But this time, you own part of the actual (often larger) properties. So it's a longer-term hold on specific projects. In all honesty, it's a very cool concept and something I regularly recommend to people who only have a couple of thousands of dollars to invest.

One of the leading crowdfunding site's average return is 5.4%. It's not amazing, and on that platform, you can't choose specific properties but an investment strategy that informs which properties they select for you.

3) Turnkey

In this case, you buy a rental that's already fixed up, already has a property manager in place, and already has a tenant. For the most part, it's hands-off, and all you need to do is come up with the down payment.

It's not my favorite choice for a couple of reasons. First, you're committing to one single-family home (and property manager and tenant). Second, it takes longer to earn an ROI because there's no value-add opportunity. Perhaps if you're buying in an area where you expect home values to increase, this makes sense, but that's speculation, not investing.

4 & 5) Private Loan Provider

You're the bank! Instead of an investor going to a traditional bank for a loan, they go to you. Usually, this works well when the property is in such bad shape that a traditional bank won't lend on it. There are two routes you can take:

4) Private

You work directly with an active investor, often called a "flipper." They buy a property for cash (using your money), fix it up (using your money), and then either sell or refinance the property to return your money + interest.

Loans are typically less than two years and for a fixed interest rate. It's secured against the property, and the potential rate of return is whatever you negotiate. Often, you provide all the funds, which can be in the hundreds of thousands range, but the investor can get multiple loans for their project, so you're one of many.

5) Hard Money

Do you love the idea of being the bank but don't want to vet investors or their projects? You can invest with a hard money lender and rely on their expertise. Returns are usually in the 6-9% range, and you can get started for as little as $25,000. This isn't a bad option if you find a company taking on new investors.

6 & 7) Limited Partner (LP)

A limited partner provides cash in exchange for equity ownership, either in the property itself or in the company that owns the property. You enjoy the profits but are responsible for supporting the losses if they arise.

An LP is similar to REITs and crowdfunding, except for a specific property without the middleman. It's also similar to turnkey, but it's before the value-added work so that you can participate in the upside. If I'm not actively involved in a project, I do this because the returns are better than all the others. There are two types of LPs:

6) Joint Ventures (JV)

These can get... creative... which is a massive benefit of equity ownership, but it makes it hard to describe. *Usually*, it's between two people - a deal provider and a cash provider - for a smaller property. You can structure it with 50/50 ownership and profits... or not.

If you own less than 25%, you're a limited partner. So, you could set up the operating agreement where you only own a small stake in the property. But, you're pledged a percentage of the net proceeds after the investment principle is returned. It's a bit of a hybrid of equity and debt while limiting your liability, and an example of how to structure a JV creatively.

The #1 rule: if it's not in writing, it doesn't exist. You'll want to get an attorney involved for this one.

If you were that kid who loved creating creative deals in Monopoly, you'll love this.

7) Syndications

Syndications are when a group of people pools their resources to purchase a larger property that would otherwise be difficult or impossible to buy on their own. The limited partners provide the down payment, and the general partners get a loan for the remaining balance. Even though the LPs might own 70% or 80% of the property, no individual owns more than 25%, which means you don't have to guarantee any loans personally.

Unlike JVs, these are a lot less creative because the SEC is involved in making sure all risks are disclosed. Typical returns are in the 10-15% range, and the minimum investment is usually $24,000 or $50,000.

Syndication Benefits

  • Leverage: The General Partners can still get a loan on the property, and everyone can take advantage of leverage as the value of the property increases.
  • Larger deals: You can pool money from multiple people and do larger deals. This allows for economies of scale, which reduces risk and costs. Risk is reduced because you're not relying on a single active investor or tenant. And you can afford a team of people to manage the deal, including a professional property manager.
  • Profits: If the project goes well, you enjoy the benefits. The nice part about larger properties is that they're more predictable than single-family homes.

Syndication Risks

  • Illiquidity: These are often 5+ year investments, and it isn't easy to get your money out before the property is refinanced or sold.
  • Cash call: in the same way you're tied to the profits, you may need to add additional cash to keep the deal moving (but hopefully not).
  • Due diligence: The deal is managed by a team of people, so there are many people with eyes on the details, but like all the other types of passive investing, you still want to vet the team and the property.

How To Get Started as a Passive Real Estate Investor

That's many options! My goal was to share enough information to point you in the right direction but not give an exact how-to plan because everyone's situation and goals are different. If becoming a limited partner intrigues you, let's chat! We'll talk about your specific situation, investment goals, and how we can partner to help you build your wealth. Schedule a call today.

Experience
the joy of building wealth
while helping to provide housing