Benefits of Passively Investing in Real Estate
Updated: Sep 17, 2020
“If you don’t find a way to make money while you sleep, you will work until you die.”
- Warren Buffet
Few things are more enticing than the idea of making money while we sleep. Set it, forget it, and let the cash roll in. While passively investing in real estate may not be that easy, it does get pretty close.
First, it’s probably worth defining what I mean when I say “passively investing” since opinions on this seem to differ. I am referring specifically to passive investors (also known as limited partners) in a syndication deal. (if any of these terms are new to you, check out my last post for definitions to these and other important real estate terms)
The sponsor finds the deal, secures the financing, purchases the property, and implements the business plan. The passive investor simply provides some cash in return for a piece of the profits. They do not make any substantive decisions. This segues nicely into the first (and hopefully most obvious) benefit of passively investing in real estate;
Don’t get me wrong, no investment is (or should be) 100% passive. At minimum, you should educate yourself on the asset you’re considering investing in. Investing in real estate is no different. Most of the work will be upfront, vetting the deal sponsors and reviewing the underwriting of the deal. Were they conservative in their underwriting? Do their forecasted returns seem outside the industry norm? I will do a separate post on vetting deal sponsors but suffice it to say, if it sounds too good to be true…run.
Will the deal sponsor be making money too? Of course! The deal wouldn’t exist without them. They are working with lenders, brokers, and managing property managers. As the passive investor, you don’t have to worry your pretty little head over things like evictions, renovations, and advertising budgets. As someone who self-manages a triplex, I can tell you the struggle is real. Even when you have great tenants, people are people, so drama ensues and things break.
Leverage the Expertise of Others
Besides not having the time to put these types of deals together, you may not have the expertise. How much have you researched job providers, demographics, and rental rates in the area you’re looking to invest in? If you said any more than “none,” then you are ahead of the curve! But putting a syndication deal together is still not quite the same as buying a duplex that you’ll buy and hold until retirement.
Once you start pooling money to buy property, the SEC gets interested. Playing fast and loose with securities laws can land you in prison, so best to hire an SEC attorney or invest passively with a team that has already hired one. In addition to the experts who need to be brought in for the deal, most syndication teams have folks with complementary backgrounds (general contractor, CPA, etc.) that leverage those skills in the execution of the business plan. You can certainly learn this business and build your own team, but until you do, lean on the experience and expertise of others to save you time and provide peace of mind.
Earn While You Learn
I think this is one of the most underrated aspects of being a passive investor. After coming to the conclusion that investing in multifamily real estate was the best path to wealth for me, I dove head-first into learning as much as could, determined to eventually become a deal syndicator myself. Sure, I could’ve bought into a mentorship program for $20k that may have had an arguable return on investment, but it was a big risk for me. I was also about to be deployed to Iraq and knew I wouldn’t have the time required to make a mentorship successful.
It dawned on me though, that by passively investing in a deal, I could better understand the investor’s perspective, learn the process, and ask questions, all while MAKING money doing it! And let me tell you, there is no better proof of concept than that first distribution check.
As obvious as this may seem, it felt like a revelation, and almost like I was cheating the system. Even while trapesing around Raqqa, Syria, I was making money, learning, and building my credibility as a real estate investor.
We all know that one of the first rules of investing is to diversify. Unfortunately, most people interpret this as owning more than just one company’s stock. Such shortsightedness can have dire consequences. Passively investing in real estate can provide that needed diversification away from an often volatile and increasingly nonsensical stockmarket.
Even within real estate, there is ample opportunity for diversification. There are different asset types like office buildings, apartments, and manufactured home parks. You can also invest in different classes of real estate from luxury Class A apartments to value-add Class C properties. Of course, “all real estate is local” as they say, and you can diversify further based on location. The Denver real estate market is vastly different from the Tampa market and the South Tampa market is different from the North Tampa market (you get the idea).
I know some people are so fed up with the stock market, that they have transitioned exclusively to different segments of real estate, a tangible asset they cannot only see and touch, but they know the value of which will never go to $0.
Some of the most discussed benefits of passively investing in real estate are the tax advantages. Many are probably familiar with the depreciation of their residence or small investment properties for tax purposes. But did you know you can take advantage of this even as a completely passive investor in commercial multifamily real estate? While every deal is different, many deal sponsors pass some of the depreciation down to their passive investors. These “losses” will be communicated on a K-1 form distributed before tax time.
To illustrate the impact of this on a small scale, I’ll use an example from my own investments. My first passive investment was a 192-unit value-add apartment syndication in Austin, TX. It was a modest investment of $25k, but over the course of one year, I made $1k in distributions. I’m certainly glad I made money, but I have a regular W-2 job and want to keep my taxable income as low as possible. Because the deal sponsor took depreciation on the deal and passed it down to his investors, I received a K-1 showing I had a net rental real estate “loss” of $5,407. So not only was I able to wipe out the $1k in distributions from my taxable income, because I had profits from other passive real estate investments, I was able to write off another $4,407 off of my taxable income thanks to my remaining “losses”!
You’ll notice I keep putting quotes around “losses”. That’s because they’re only real in so far as the IRS says you can count them as a loss. If the idea of making tax free profits from your investments doesn’t excite you, you may want to check your pulse.
I have only scratched the surface of a few of the benefits of passively investing in real estate. I will dive deeper into some of these and other benefits in future posts. There is no one investment that’s right for everyone, as we all have different goals, risk tolerances, etc. But given the examples I’ve laid out; I hope you at least consider learning more about how passively investing in real estate can help to diversify your portfolio and grow your wealth.
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Ready to start passively investing in multifamily real estate and want to see if our opportunities might be a good fit for you? Click here to visit our website to learn more or reach out to me directly at Tim@ZANAinvestments.com.