Summary: If you’re just starting to think about investing in real estate, you’ve probably thought about this question: should I pursue passive or active investing? It’s a good question and one that’s probably pretty hard for a newbie to figure out. In this article, we do a head-to-head comparison of passive vs. active investing. Bottom line: active real estate investing is generally more work, but you can make 10x more than you can with passive investing.
[Disclaimer: We are not accountants, lawyers or financial advisors, so please consult your own team of professionals about the topics covered in this article.]
If you’re thinking about investing in real estate, you’ve probably figured out by now that there are lots of options for real estate investing, ranging from passive to active.
So how do you choose?
While there are many factors to consider, one of the most important should be the return on investment. For example, if you knew that you could make 10x more with one investing option vs another, would that matter to you? It should.
So, which of these options can make you 10x more than the other? Let’s dive into passive and active real estate investing and find out!
What is passive real estate investing?
Passive investing is leaving the acquisition and management of properties to someone else. Someone else does the work and you passively receive a certain return on investment.
There are many ways to invest passively in real estate: Real estate investment trusts (REITs), real estate funds, syndications, and crowdfunding.
For this example, we’ll be focusing on real estate syndications. If you want to learn more about investing passively in syndications, CLICK HERE.
With syndications, the passive returns generally range from 10-15% on average. Some do better, some do worse. A common metric used by sponsors of these syndications is two times equity multiple in five years. This means that if you put in $100,000, in five years, you’ll get back a total of $200,000 ($100,000 of this is your original investment).
What is active real estate investing?
With active real estate investing, you do all of the work of acquiring and managing the property. Some also refer to this as direct ownership.
The property can be of many different types: single-family homes, multifamily, commercial, retail, mobile home parks, and storage units.
For this example, we’ll be focusing on multifamily rental properties.
There are numerous approaches to investing in rental properties. Some people invest for market appreciation, some invest for cash flow — we do both, and then some. We call it The Fast FIRE System and combine all of the ways you can make money with these properties: cashflow, immediate appreciation, forced appreciation, renters paying down your mortgage, and tax savings. When you combine all of these and you do it the way we teach, you can achieve a very high rate of return. This return far surpasses what you would normally imagine you could make from rental properties as you’ll see from the example below.
The two investment scenarios
So now let’s assume you have $100,000 to invest. You have two choices. The first option is to passively invest in a real estate syndication. The second option is to actively invest in multifamily properties.
Let’s see how each of these turns out after 5 years.
The passive investment scenario
The first thing you have to do when investing passively is to decide, where to invest this money.
Let’s assume you narrowed it down to investing in real estate syndications. Great.
Now you have to figure out where to find syndication opportunities. You certainly don’t want to use a Google search to find a random investment opportunity. Ideally, you know the deal sponsor or have friends who can vouch for the deal sponsor.
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You also want to get access to the best deals. One of the best ways to do that is to increase your deal flow. The more options you have to choose from, the better.
Let’s now assume you’ve networked, met some deal sponsors, and have started to get deal flow. The next task is to figure out where to put your money. How do you choose? You have to do your due diligence. The due diligence process is fairly involved, and you’d need a course worth of material to learn how to do it properly.
Some shortcut this process by just investing with who they know. Someone they know says, “hey, you should invest in this deal.” Most of the investors we know do a cursory review of the deal before sending in their money.
Assuming you don’t short-cut it and actually do your due diligence, it’s not sounding too passive is it?
From there, you send in your paperwork to prove that you’re an accredited investor, you sign the paperwork the deal sponsor sends to you and then you wire $100,000.
Then over the next five years, you wait.
The following is what the next five years feel like.
You’ll get monthly or quarterly updates. Maybe the deal sponsor sends you a little bit of money over the five years, maybe not.
If you need the money for some reason (maybe you have a family emergency), you can’t access that money. It’s completely illiquid.
The deal sponsors send you a K1 tax form each year so you can do your taxes. You might be surprised (not in a good way) to find out that you can’t shelter any W2 or 1099 income with the losses in the K1. You’d have to achieve real estate professional status in order to do that.
[If you’re interested in learning more about REPS, check out our guide HERE]
After five years, assuming things go as expected and you get the two times equity multiple you were hoping for, you receive a total of $200,000. $100,000 of this $200,000 is the original investment you put in five years before. The other $100,000 is your profit.
The active investment scenario
Now let’s look at the active investment scenario.
As you read through this, pay attention to a few things. You will see how you have control over your money. If something happens like a family emergency, you can choose to sell the property and get your money out. You will also see how you can re-use the same money over and over again during a five-year period. This is called the velocity of money. Unlike on the passive side of things, if you want to make another $100,000 investment, you have to save until you have this amount of money in the bank. How long does it take you to save up $100,000?
In this scenario, instead of investing $100,000 in a syndication, you are using this money to buy a multifamily rental property and fix it up. Note that this scenario is based on the experience of one of the students of our Zero to Freedom course. Some of the numbers are rounded up or down but they approximate what really happened.
With the $100,000, you go out and buy a $200,000 duplex, putting down $50,000 or 25%, which is a standard amount for rental properties. There are many ways to put down less than 25%, but for the purposes of this article, we are going to be conservative and assume that you put down the standard amount.
You use the remaining $50,000 to force appreciation. This means you force the value of the property to go up by making value-add improvements to the property. In this case, our student added three bedrooms and a bathroom to one side of the duplex. After six months, as a result of these improvements, the property was now valued at $350,000.
This allowed our student to do a cash-out refinance and get a loan for $250,000 (this amount represents 70% of $350,000, the new appraised value). Using this loan, he was able to pay back the old loan and get his $50,000 downpayment back. He was also able to get back the $50,000 he put in for the renovation.
He still has $100,000 of equity in the property ($350,000 minus $250,000).
In terms of cashflow, he rented the property as a mid-term rental and was able to cashflow about $20,000 per year.
The renters are also paying down his mortgage, around $3,000 per year.
Finally, in terms of tax savings, he was able to create a $100,000 tax shelter with this one property, which generated a $25,000 tax refund the following year.
All of the above took about 6 months, so now he can take the $100,000 he got back after the cash-out refinance and do it all again on another duplex (which he did).
Now let’s assume he does the same thing over and over again every 6 months for the next 5 years. This is what we mean by the velocity of money. The same $100,000 that passive investors tie up into a syndication can be recycled over and over again, 10 times over 5 years to be exact.
Doing the math, here is what it looks like to recycle the same $100,000 and use it to acquire a $200,000 duplex, every 6 months.
By the end of 5 years, you have:
- Equity of $100,000 x 10 properties = $1 million
- Cashflow over 5 years from 10 properties = $450,000
- Debt paydown from 10 properties = $67,500
- Tax savings from 10 properties = $250,000
When you total it up, you make $1.77 million with your original $100,000 investment. Compared to the $100,000 you make with a passive syndication, that’s 17.7x!
Now let’s make some adjustments to the above.
Some might argue that tax savings should not be counted because you have to eventually pay back the bonus depreciation (this is called depreciation recapture). However, this only occurs if you sell the properties. In this scenario, we’re holding onto the properties and not selling any of them. Even if we did sell them, we would use a 1031 exchange to defer paying back the bonus depreciation.
[Need a 1031 exchange specialist? CLICK HERE for an introduction!]
On the flip side, what we didn’t include in the above scenario is the potential for you to re-invest the tax savings. With each duplex, you generate $25,000 in tax savings. So after 2 years of investing, you would have accumulated another $100,000 that you could use to buy yet another duplex. This would make your return even higher than 17.7x.
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Key takeaways
If you’ve ever wondered, why the heck would anyone want to go through all of the trouble actively investing in rental properties?? The bottom line, it’s that you can make 10x more with active investing!
It’s important to point out that you can’t just go out and buy any property. You HAVE to know what you’re doing.
If you want to implement The Fast FIRE System and achieve results as our students did, there are a lot of things to learn, and you have to implement multiple things at once. Below are a few of the things you’ll need to know how to implement:
You have to learn how to find properties that cashflow, then you have to maximize cashflow – in our active example, our student rented his property out as a midterm rental. You will also have to learn how to find properties with hidden value. Our student found a property that allowed him to add three bedrooms and a bathroom to one side of the duplex. You have to learn how to get immediate appreciation. This is when you buy a property at a discount, so you have equity in the property from day one. You have to learn how to get great loan terms. Ideally, you figure out a way to put down less than the standard 25%. You have to learn how to maximize the tax savings using bonus depreciation and also learn how to write off property expenses as repairs instead of them being capitalized. These are just a few of the things you’ll need to know to implement The Fast FIRE System and exactly what we teach in our Zero to Freedom course.
If you want to achieve financial freedom while you’re young enough to enjoy it, you have to maximize the return from your investments. A two-times equity multiple every five years isn’t going to cut it. It’ll take over 20 years before you can consider yourself financially free. It’s your time to choose.
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