Real estate can be a lucrative form of investment. Not only will it diversify your investment portfolio, but the chances of substantial returns are high. There are three main types of real estate investing are as follows and they each have ways of generating revenue.
To get started in real estate investing, we first recommend you read our article, "The Basics of Active Real Estate Investing" prior to diving into passive real estate investing.
What is Passive Real Estate Investing?
Now that you have an understanding of real estate types you can invest in and ways you can generate money from your investments, we will dive into the hands-off approach to real estate investing, passive investments.
Passive real estate investing allows you to invest in real estate without the need to physically do anything. Both novices and experienced investors alike can passively invest in real estate. With this form of investment, investors only provide the capital. Investing professionals then take the money and invest it on their behalf (similar to a portfolio manager with stocks).
The biggest downside of passive real estate investing is that it usually involves large sums of money that are tied up for long periods, so it's not always accessible for the general public. There are four main types of passive real estate investments: private equity funds, Opportunity Funds, REITs, and online real estate investment platforms.
Private Equity Funds
A private equity fund is an investment model where investors pool their money into a single fund to make investments. Almost every private equity fund has a manager in charge of directly managing the equity fund's investments. Because of the active role of the fund's manager, investors are not required to be directly involved. However, just like with any real estate investment, it helps to have a financial and real estate background to understand the risks and potential returns of each investment.
The downside of private equity funds is that they are difficult to join. The minimum investment to join a private equity fund is typically around $100,000, but it can be much higher. Private equity funds use a "two and twenty" model, meaning they charge a 2% annual management fee, and an additional 20% fee on any profits that the fund earns.
An Opportunity Fund is an investment model where investors pool their money to invest in Qualified Opportunity Zones. Opportunity Zones are tracts of low-income communities where the government encourages private investments to improve the neighborhood. By law, the government requires 90% of an Opportunity Fund to go toward improving the impoverished areas with new buildings and the redevelopment of previously unused properties.
Those who invest in Opportunity Funds can receive substantial capital gains tax incentives for their investments. An Opportunity Fund allows an investor to defer taxes on their capital gains until 2026. This typically translates into a 10-15% reduction in tax liability on their deferred gains, depending on how long they hold the investment. If the investment is held longer than ten years, any capital gains earned from Opportunity Funds investments will be excluded from any capital gains taxes.
Real Estate Investment Trust (REITs)
A REIT is a company that makes equity investments in commercial real estate. Investors purchase shares of this company and earn an income from the equity it gains in the form of dividends. Unlike a Private Equity or Opportunity Fund, some REITs allow ordinary investors to take advantage of passive real estate investing. Legally, a REIT must earn 75% of its gross income from real estate and invest 75% of its assets in real estate. They also have to distribute at least 90% of their taxable income to their investors each year. There are three main types of REITs: private, publicly-traded, and public non-traded.
Similar to Private Equity Funds, private REITs are limited to investors with a high net worth, as they have high minimums and high fees (usually around 15%). They also require that the investor be able to invest large sums of money for long periods.
Publicly Traded REITs
On the other hand, publicly-traded REITs have no investment minimum other than the price of the share; they're also registered with the SEC and traded in the stock market. Although publicly-traded REITs are easily accessible to the public, they're also one of the more volatile real estate investments since they're correlated to the public markets.
Public Non-Traded REITs
Considered the middle ground between a private REIT and a publicly-traded one, non-traded REITs are registered with the SEC like publicly-traded REITs, but they're not traded on the stock market. Public non-traded REITs can be either open or restricted, and their investment minimums can vary.
Online Real Estate Platforms
Online real estate platforms are the easiest way for individual investors to take advantage of real estate investing. With online real estate platforms, you can either choose to invest in a single investment or a diversified portfolio of real estate. Some investment platforms only offer debt investments, while some offer both debt and equity investments. Make sure to research the right platform for your situation, as they each have their own requirements and capabilities.
Take Your Knowledge Further
Now that you understand the basics of passive real estate investing, are you ready to take your knowledge to the next level? Take our Real Estate Pre-License course to learn advanced real estate knowledge and prepare you (if you'd like) to become a licensed real estate agent. Start your training today!
Written and Published by: VanEd