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Are you ready to build generational wealth, accelerate your retirement funds or level up your investment game? Multifamily real estate could be the perfect opportunity for you. But before you dive in headfirst, it's important o consider whether passive or active investing is the right approach for you. We'll break down the pros and cons of each approach, share expert tips, and answer some common questions about multifamily real estate investing. Get ready to discover your path to success in this exciting and dynamic industry!
Explanation of Passive and Active Investing
Hands off Investor - Passive Investing in Multifamily Real Estate
Passive investing in multifamily real estate specifically refers to the act of investing in a multifamily property, an apartment complex, without being directly involved in its day-to-day operations. in other words, the investor provides the funds necessary to acquire and manage the property but doesn't take an active role in finding the right investment opportunity, negotiating with the broker or seller, or an active role in its management or decision-making process as well as dealing with having to sell the property. This type of investment is often appealing to busy professionals who don't have the time or desire to manage a property themselves, but still want to benefit from the potential returns that real estate investing can offer.
Passive investors typically invest in multifamily real estate through syndications, which are private investment partnerships between a sponsor (the active manager of the property) and multiple passive investors. The sponsor is responsible for finding, acquiring, and managing the property, while the passive investors provide the necessary capital to make the investment possible. A good sponsor team should also have some "skin in the game" meaning they invest some of their money as well.
Passive investing in multifamily real estate has several advantages, including;
Less Time Commitment: Passive investing requires little to no active involvement from you, allowing you to focus on other things such as your family, hobbies. It allows you to stop trading time for money and have you money work for you. Once invested, you would receive monthly updates about the property and either monthly or quarterly distributions, known as mailbox money without any effort or sweat equity.
Lower Risk: With passive investing as a Limited Partner (LP) in a syndication, you're not responsible for managing the property or making critical decisions. In return, if the investment were to go sideways, the bank would not be able to come after you and only go after the general partners or sponsor team. The main risk is losing your investment but nothing further.
Diversification: Passively investing as an LP can provide diversification across multiple properties, and different markets. This also can diversify your retirement funds and free your money form the volatile rollercoaster of the stock market.
Tax benefits: Passive investing in multifamily real estate offers tax benefits such as depreciation deduction, passive activity loss, 1031 exchanges, qualified business income deductions.
However, passive investing also has some potential drawbacks, including:
Limited Control: As a passive investor, you have little to no say in how the property is managed or the decisions that are made. A good sponsor team should have a strong plan to achieve their projected returns and might hear your suggestions, but this might be a deal breaker if you are someone who HAS to have control.
Fees and Expenses: LPs can come with fees and expenses such as asset management fees, acquisition fee, and others. These are fees paid to the General Partners (GPs) for finding the deal, managing and improving the property and for securing the loan on the property.
Active Investing in Multifamily Real Estate
Active investors in a syndication are generally referred to as General Partner or Sponsor. They spend a large amount of time doing market research, building relationships with
brokers, analyzing multiple, multiple, multiple deals to find the right investment opportunity. They role their sleeves up and take an active role when it comes to finding, acquiring, managing and improving, and selling the property. It takes time and effort to finding the right investment and have to take a hands-on role in the day-to-day management and decision-making of the property, with the goal of maximizing its profitability and value.
Active investors need to be creative and strategic to customize management strategies to fit the specific property and markets, as they hold a responsibility to the limited partners to achieve projected returns. With an active role you need to have a deep understanding of the local real estate market and property management, as well as access to financing, legal and accounting services, and other resources necessary to manage the property effectively.
If you're just starting out and want to be an active investor, you will partner with a sponsor who has a proven track record. As most lenders require you to provide a Schedule of Real Estate Owned (SREO), a document that present a schedule regarding information related to all real estate owned by and investor. The document lists out all of the properties the investor has either full or partial ownership of.
The main advantage active investing has over passive investing
Greater Control: As an active investor, you have full control over the property and the decisions that are made.
Tax Benefits: If your status is real estate professional, you can have greater tax advantages for the same things listed as the limited partner.
However, active investing also has some potential drawbacks, including:
Requires Significant Time Commitment: Active investing requires a significant time commitment to finding and managing the property.
Higher Risk: Active investing comes with higher risk since you're responsible for making all the decisions and managing the property. It also comes with higher risk when being the guarantor on the loan.
Comparing Passive and Active Investing
When deciding between passive and active investing in multifamily real estate, it's important to consider your goals, risk tolerance, and time commitment. Here are some key factors to consider:
Investment goals: If your primary goal is to generate passive income and diversify your investment, passive investing may be the better choice. However, if you're not able to give up control and are willing to put in the effort, active investing may be a better fit.
Risk Tolerance: Passive investing generally comes with lower risk since you're not responsible for making critical decisions nor guaranty on the loan. Active investing, on the other hand, requires you to take on more risk when acquiring and managing the property.
Time Commitment: Passive investing requires little to no time commitment, while active investing can be a full-time job. Consider your schedule and how much time you're willing to dedicate to finding, managing, improving and selling the property and creating reports to present to the passive investor or limited partners.
Key Factors to Consider Before Investing in Multifamily Real Estate
This is where passive investing is not so passive. So regardless if you're considering passive or active investing, it's important to consider several key factors:
Location: location is critical when investing in real estate. Look for markets with strong job growth, population growth, rental demand. Active investors need to take a deeper dive into this and look at crime rate, school district ratings, average median income (AMI) in the area, neighborhood amenities and more to ensure this is a right investment location. This will help determine the area classification, whether it is a class A (great), class B, C or D (rough area).
Property Types: Consider the type of property you want to invest in, just as location classification, there is a what is called asset classification. Class A that typically is a newer built with higher amenities, down to class B, C, and D as the property gets older and is more rundown.
Investment Strategy: Determine the investment strategy, such as value add, core investing, new development, or opportunistic.
As a passive investor this is where you need to have an understanding or knowledge of the market locations, property types and understand the different investment strategies. As an active investor, you must have a much deeper understanding and knowledge, as this will help mitigate risk and avoid bad investments.
Common Mistakes to Avoid when Investing in Multifamily Real Estate
When investing in multifamily real estate, there are several common mistakes to avoid, including:
Not Doing your Due Diligence
- Passive Investor: Not thoroughly researching the lead sponsor team, the investment opportunity or having a basic understanding of the market.
- Active Investor: Not touring the property with a qualified inspector, or thorough research on the properties income and loss statement, and the market demand.
Failing to Plan for Expenses: This is mainly towards active investors, not making sure to factor in all expenses, including maintenance, repairs, and property management fees, as well as plans for any contingencies when calculating potential returns.
Ignoring Market Trends: Pay attention to market trends and adjust your investment strategy accordingly.
Conclusion
Which role better fits you? Are you willing to commit the time and efforts to be active or do you want to generate truly passive income?
Investing in multifamily real estate can be a smart way to generate passive income and build generational wealth. We hope this has provide you with valuable insights and information on the differences between passive and active investing in multifamily real estate. Whether you choose to invest passively or actively, it's important to approach each opportunity with careful consideration and diligence.
Remember, investing in real estate is a long-term game. It requires patience, perseverance, and a willingness to learn from your success and failures. With the right approach, multifamily investing can b a powerful tool for building financial freedom, which means you don't have to keep trading your time for money. No more picking up extra shifts or spending long hours at work, gain time freedom as you build generational wealth.
If you're interested in learning more about multifamily investing or have any questions, don't hesitate to reach out to us at RA Multifamily Investments. Join our Monthly Newsletter where we share strategies tips and resources to help you achieve financial freedom through multifamily real estate investing. You can also visit our website for more frequently asked questions (FAQs) and key terms.
This is to be informative and not legal tax advice when investing in multifamily real estate, whether passive or actively. Always consult with a certified CPA or tax advisor who is familiar with Multifamily Real Estate and your specific situation.