When most people think of real estate investing, they think of house flipping, rental properties, and Airbnb. But this is only one category of real estate investment. Your knowledge of real estate investing basics is only complete once you understand all the options.
Below, we’ll explore active versus passive real estate investing. What distinguishes the two strategies? Which one is for you? And what are your options in the world of passive real estate investing?
Active vs. Passive Investing
In general, there are two types of investment: active investing and passive investing. At the root, the difference is “hands-on” versus “hands-off,” but if we apply those concepts a little differently when we’re talking about real estate investment strategies than when we’re talking about stocks or commodities.
In the stock market, active investing means that someone manages the investment in a hands-on way – buying and selling frequently. Even if the one doing the management is a professional working on behalf of the client, it’s still considered active investing. Passive investment means that little buying or selling goes on at all – the investor sits on the stock for extended periods of time.
Lay people often see all real estate investing as passive because, from a labor perspective, we often talk about owning a rental property as providing “passive income from real estate.” But there’s a difference between passive income and passive investment.
When we use the terminology of real estate investment strategies, we distinguish active from passive based on the degree of control and ownership an investor has over specific property.
Active real estate investing involves owning specific property and managing it for a profit. You might rent for income, flip the property to another seller, or simply profit later when your real estate appreciates in value. Even if you hire a third party to do the daily boots-on-the-ground work, it’s considered active investing if you make the strategic decisions for properties you can point to as “yours.”
You can learn more about the active real estate investing basics in this article.
In passive real estate investing, you’re disconnected from strategic decisions, and you may not even be able to claim ownership of the property your money’s invested in. You’re just putting up capital and getting a return if there’s one to be had. It’s more like owning stock, but you’re investing in real estate rather than a company.
It’s easier to understand when you look at examples of different types of passive real estate investments.
What is Passive Real Estate Investing?
When you participate in passive real estate investing, you provide capital to an investment professional who, in turn, selects real estate investments and makes strategic decisions to create a profit. Sometimes, a passive real estate investor has remote ownership over a property, but sometimes, they don’t.
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 to the general public.
Below, we’ll talk about four types of passive real estate investment available in 2024: private equity funds, Opportunity Funds, REITs, and online real estate investment platforms.
Private Equity Funds
A private equity fund is an investment model where multiple investors pool their money to be managed as an investment over an extended period.
In most cases, private equity funds have a manager playing a direct, active role in managing the equity fund's investments. Because of the active role of the fund's manager, investors are not required to be directly involved.
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.
Opportunity Funds
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 Fund investments will be excluded from any capital gains taxes.
Real Estate Investment Trusts (REITs)
A REIT is a company that makes equity investments in commercial real estate. Investors purchase shares of this company and as it gains equity, they get passive income from real estate 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.
Private REITs
Similar to Private Equity Funds, private REITs are limited to investors with 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
Publicly traded REITs are registered with the SEC and traded in the stock market.
In contrast to private REITs, publicly traded REITs have no investment minimum other than the price of the share. This makes them easily accessible to the public.
The downside is that 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. They’re less liquid than traded REITs but that makes them more stable.
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
Novices are sometimes drawn to passive real estate investing because it seems like it requires less real estate knowledge than active real estate investments.
This isn’t entirely true. To maximize the returns of passive real estate investment, it helps to have enough financial and real estate background knowledge to distinguish a good investment from a bad one.
One way to acquire advanced real estate knowledge is to study real estate pre-license curriculum. Earning a real estate license can be very useful for a savvy real estate investor, but even if you have no intention of completing the process, you’ll get a solid foundation of real estate knowledge to draw from as you make investment decisions.
Written and Published by: VanEd
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