Many people dream of investing in real estate to help them build long-term wealth and enjoy a regular income stream during retirement. In fact, 45% of Americans consider real estate to be the best long-term investment — it beats stocks, bonds, gold, and savings accounts.
Unfortunately, real estate investing often comes with high start-up costs (not to mention a lot of work). After all, most people can’t afford to buy an apartment complex, office building, or a slew of single-family homes to rent out.
The good news is passive real estate investing is more accessible and affordable, allowing anyone to add real estate to their investment portfolio.
Keep reading to learn how passive real estate investing works, the different passive real estate investments, the pros and cons, and more.
What is passive real estate investing?
Passive real estate investing is a strategy that allows someone to make money from real estate without actively managing it.
Because it’s passive, there’s no real hands-on effort. Just like buying a stock or a bond, once you make your initial investment, you can just sit back and watch it generate income.
You receive stable cash flows and long-term capital growth as the value of a stock or an underlying property increases. And you can do all of that with a lower cost and less risk than is required for traditional real estate investing.
Passive vs. active real estate investing
Passive real estate investing is significantly different from what most people probably picture when they think of real estate investing.
When you invest in active real estate, you typically buy and manage a property.
As a result, active real estate investing requires a far more significant upfront investment since you have to buy an entire property instead of just a small piece of one. In addition, in most cases, investors must finance their real estate investment purchase with a mortgage, which is rarely the case with passive real estate investing.
Active real estate investing is also considerably more work.
There’s far more hands-on effort since you often manage the property yourself. However, that also means you have more control over your investment.
Passive real estate investing, on the other hand, is a hands-off process. Rather than managing a property yourself, you simply pass your money along to a company that does that on behalf of investors.
3 methods of passive real estate investing
If you’re considering adding a passive real estate investment to your portfolio, you have three primary options: REITs, real estate crowdfunding, and real estate funds.
A real estate investment trust, or REIT, is a company that owns and manages properties.
REITs can own residential properties and commercial buildings like shopping malls or storage facilities.
Many REITs are publicly-traded companies, meaning you trade on public stock exchanges. And when you buy shares in the REIT, you become a partial owner of the company just as you do when you purchase stock in any other company. As a result, you get a share of the REIT’s income.
REITs have some tax benefits where they don’t pay taxes on the dividends they pass along to shareholders. But to earn that right, they must meet a handful of requirements:
- Pass along at least 90% of their taxable income to shareholders as dividends
- Be companies that would be taxable as corporations if not for being REITs
- Be managed by a board of directors or trustees
- Have fully transferable shares
- Have at least 100 shareholders by the end of the first year
- Have no more than 50% of their shares held by five or fewer shareholders
- Invest at least 75% of their assets income in real estate and cash
- Get at least 75% of their income from real estate sources
- Get at least 95% of their income from real estate sources and dividends or interest
- Have fewer than 25% of their assets be non-qualifying securities or stock in taxable REIT subsidiaries
There are also private REITs and public non-traded REITs that aren’t listed on public stock exchanges.
Finally, some REITs are mortgage REITs, which make money by financing real estate purchases, including originating or purchasing mortgages.
2. Real estate crowdfunding
As you likely know, a crowdfunding site allows many people to pool their money together to fund a particular cause.
But unlike sites like GoFundMe, where you’re funding a charitable cause, real estate crowdfunding pools your money with other investors to earn a profit.
In real estate crowdfunding, one party — typically the real estate company — makes the opportunity available to investors. Then individual and institutional investors can invest a sum of money that the real estate company then pools together with other investors’ money to purchase and manage properties.
Like REITs, real estate crowdfunding often provides dividends to investors, but they may not be legally required in the way they are with REITs. These investments may also have fees and need investors to keep their money invested for a certain period.
Finally, some real estate crowdfunding platforms are only available to accredited investors, those with an income of $200,000 or more (or $300,000 or more when combined with a spouse) or a net worth of $1 million.
3. Real estate funds
A real estate fund is a mutual fund whose underlying investments are real estate companies.
Real estate funds are often made up of REITs. But rather than investing in just one REIT, you can gain exposure to dozens — or even hundreds — of REITs in a single investment.
These funds may be either actively managed or passively managed.
An actively managed fund has a fund manager who buys real estate stocks in the fund. A passive fund tracks the performance of an underlying benchmark. For example, the Vanguard Real Estate Index Fund tracks the MSCI US Investable Market Real Estate 25/50 Index.
Real estate funds offer many of the same benefits as REITs, including the potential for dividends. They also benefit from added diversification since you’re investing in many real estate companies instead of just one.
Pros and cons of passive real estate investing
Passive income has major benefits that may convince you to add it to your portfolio. But before you do, it’s also essential to consider the downsides.
Pros of passive real estate investing
- Lower upfront investment: Buying real estate usually requires a major upfront investment. And since most people can’t afford a property in cash, financing is often needed. But a real estate investment has a far lower upfront investment, making it more accessible to the average investor.
- Potential for steady cash flow: Passive real estate investments often pay regular dividends to their investors. This type of income can serve as an excellent contrast to assets that have more of an emphasis on long-term capital gains. Additionally, you can reinvest those dividends to grow your portfolio even more.
- Higher liquidity: Passive real estate investments are far more liquid than traditional ones. If you own a rental property, it’s pretty challenging to quickly turn that investment into cash. But if you own a REIT, for example, you can quickly sell it off as you would any other stock.
- No previous knowledge required: Passive real estate investing doesn’t require any prior knowledge of real estate because you aren’t the one managing the properties. Instead, a company with experienced professionals works on your investment, benefiting you.
- Less hands-on effort: Managing an investment property can be time-consuming. A passive real estate investment is far less hands-on, which clears up more of your time for other things.
- Limited downside risk: When you invest in passive real estate investments, your risk is limited to the amount you invested. But if you owned a property, your downside risk could be far larger.
Cons of passive real estate investing
- Less profitable: When you own your investment property, any money left after expenses is yours to keep. But with a passive real estate investment, a share of your profit must also go to the company managing the property, resulting in a smaller profit.
- Vulnerable to market fluctuations: Your downside risk may be more negligible with passive real estate investing, but there is still some risk. As the real estate market shifts, you could see your dividends go down if properties sit vacant or borrowing costs rise.
- Less control over the project: As a passive real estate investor, you have no control over the project. You simply hand your money over to a company that manages it as it pleases. While this is fine for many investors, some may prefer projects, with some say over the direction.
- Potential liquidity issues: Passive real estate investments are more liquid than actual properties. But there are some issues, especially if you aren’t buying publicly-traded REITs. For example, some passive real estate investments have lock-up periods, so you can avoid this issue by purchasing REITs from a public stock exchange.
Is passive real estate a good investment?
Passive real estate can be an excellent way to diversify your money, add a recurring source of income, and build long-term wealth.
But it’s not suitable for everyone.
So here are a few questions to ask yourself when deciding whether passive real estate is a good investment for you:
- What is your investment goal? If your goal is to create a steady source of income, passive real estate is an excellent way to do that. However, investing in stocks may have a different long-term capital growth than you might get.
- How will real estate fit within the rest of your portfolio? Diversification is a crucial principle of investing. Before adding passive real estate to your portfolio, ensure you have a good balance of other assets, including stocks and bonds.
- Would you prefer to play a more active role in your investment? Passive real estate can be an excellent choice for someone who wants a hands-off investment. But if you want to play a more active role as you would have with managing your investment property, then the investments we’ve talked about may not be suitable for you.
A lack of capital or time doesn’t have to hold you back from becoming a real estate investor.
Through passive real estate investments like REITs, crowdfunding, and real estate funds, you can enjoy all of the benefits of owning real estate — without having to own real estate.
Of course, being a passive investor in real estate isn’t without its downsides, especially for someone who wants more control of and profit from their investments.
If you’re considering passive real estate and are wondering if it’s right for you, be sure to consider your short-term and long-term investment goals, what type of real estate investing interests you, and how it will fit into the rest of your investment portfolio.