Is owning real estate passive investing? Below we discuss whether owning direct real estate is passive investing. You might just be surprised by what I say.
A teaser … Owning Real Estate is NOT Passive Investing!
Find out why and learn about two other real estate investments that will help you passively invest in real estate without the headaches that come along with direct ownership of real estate … Real Estate Investment Trusts (REITs) and Real Estate Private Equity. Both of which provide passive income from real estate, but one is better than the other. Can you guess which one?
In this detailed post and shorter video, we’ll take a deep dive into real estate investing and specifically whether real estate is passive. And whether adding real estate to your existing stock and bond portfolio makes sense? We will discuss the three real estate investment types and discuss how passive each is relative to one another.
The “Sleep Factor”
Why the picture above of a sleeping family and simply gorgeous baby? Well, I call this the ‘Sleep Factor’, which I detail below. But, when considering an investment, any investment … one of the most important criteria should be whether that investment could keep you up at night.
Your goal when making investment decisions should be worry free investing … to sleep soundly.
YouTube Video or Read Below
What is Passive Income?
I’m sure you have seen recently, all over the internet there are people saying that you need to have multiple income streams in order to be a successful investor. They also continually repeat that passive investing is a must. Some of what they are ‘preaching’ is spot on. As an example, getting your money to work for you is imperative to building wealth.
Passive income refers to earnings that are generated without the need for active involvement or effort on a regular basis. In other words, it is money that is earned through investments, rental properties, online businesses, or other passive activities that require minimal ongoing effort or time.
Passive income is often contrasted with active income, which is earned through employment or self-employment, where one must work actively to earn money. Passive income can provide financial stability and freedom, as it allows individuals to earn money while they sleep or focus on other pursuits.
And herein lies the key to passive investing … if you are making money while you are able to focus on other activities or sleeping, it is most likely passive.
Is Real Estate Passive Investing?
Based on the above definition, it would seem that owning real estate that generates income (like a rental) would be considered passive investing. And these same people on the internet are quick to suggest exactly this … that owning real estate is one of the best passive investing streams that you can have.
But, having owned multiple rental properties over the years, I can tell you that owning direct real estate is not passive investing. I think the confusion lies in the fact that since it is not a 40 hour per week job and you can own real estate and have a regular job at the same time, that some would conclude this as passive.
But for me there is more to consider than just the 40 hour per week test.
Owning Real Estate Takes Rent in Your Head
For me true passive investing has to pass what I call the Sleep Factor. If you are invested in something that has the potential to keep you up at night, then it is not passive. If you are stressing about it … it might not be taking your time, but it is taking up space in your mind.
So, what could keep you up at night with real estate, well the obvious ones are financial. If you are like most people, with direct real estate you are putting down a lot of money that you can’t afford to or certainly don’t want to lose. The more money, the more stress.
Bad Tenant and Building Repairs
When you have a good tenant and everything is going well, there is no stress. But inevitably you lose sleep: the tenant moves out, tenant is not taking care of the property, something breaks in the middle of the night, your mortgage or property tax is increasing, insurance is increasing.
Of course, the counter argument to this is, “if you are stressed owning real estate, you can hire a property manager to take care of the issues for you”. And, yes, a manager does take some of the stress of owning real estate away, but they won’t be able to solve all the issues.
In fact, it is really hard to find real estate that has enough margin in order to eliminate these stress points. I certainly have never found it if it exists.
Some Stress More Than Others
And … I’ll admit that every type of investment is not right for every person. And, just because it isn’t right for me or you, doesn’t mean it isn’t right for someone else. My goal here is not to bash on directly owned real estate, but to point out the drawbacks and from there, each person needs to decide if it is a good investment for them. Because even though real estate is not passive, it is still a fantastic investment for some people, many people!
And maybe I’m just not that person. But, these are factors to consider anytime you are looking at a new investment in anything. In order to evaluate a new investing, I find it helpful to think of the worst possible scenario and consider whether I would want to deal with those issues, and as a result, it answers the question as to whether it is a passive investment or not.
I love real estate and think it is an amazing way to diversify your stock and bond portfolio. I also love the tax benefits of Real Estate investing, so I’m a huge fan … but for me, owning real estate directly doesn’t solve my sleep factor and therefore I’m not interested.
So what’s the solution? There are two other ways to invest in real estate that are much more passive in nature.
Can adding Real Estate make your Investment Portfolio safer?
Reduce Taxes, Less Volatility?
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REITs – The Solution to Real Estate Passive Investing
The first is REITS or Real Estate Investment Trusts. I have a detailed blog about REITs and their comparison with direct real estate ownership and real estate syndication. If you prefer video, check out our YouTube Channel or the actual video about REITs vs Direct Real Estate vs Real Estate Crowdfunding
Basically REITs are very similar to owning any stock in the stock market. You invest in a company and they do the work for you. And, for your investment, you receive distribution / income, which is similar to how a dividend works. The only difference between a REIT and another other stock out there, is that REITs own and operate rental real estate properties vs a company like Apple that makes technology products.
So, you invest in a company, they do the work, you receive checks. You are limited in your involvement … this sounds passive to me.
REITs provide passive income and since they are stress free, I think it qualifies. I consider a REIT a passive investment. Like owning any stock in the stock market, I love them.
But, for me, there are a few additional criteria when looking at investing in stock market alternatives. And REITs don’t check the other checkboxes of why I would invest in Real Estate.
REITs are Volatile and Have a High Correlation With the Stock Market
I covered this topic in a previous post, What are Defensive Investments?. And, again in video in our 5 Defensive Investments In The Stock Market.
REITs have a higher correlation with the stock market. When people are fearful, they tend to want to exit all their investments. And since REITs are easily bought and sold through your brokerage account, they tend to decline just as much as traditional stocks.
And, so for me, if a REIT has the potential to drop as much as my other stock market investments, I don’t see the value in investing in them. I invest in real estate for diversification from my other investments, and therefore the REIT does not address that issue.
REITs Will NOT Help You Reduce Your Taxes
Another huge issue I have with investing in real estate with REITs is that they provide no special tax treatment. In fact, the income that you receive from a REIT is treated as ordinary income. This ultimately means it is actually worse than investing in a dividend stock from a tax perspective. And, in general the returns are not as good as a dividend stock investment.
Ultimately, REITs solve the Sleep Factor, but so does investing in defensive sectors in the stock market.
Real Estate Private Equity – True Passive Investing
The last way to invest in real estate is through Real Estate Private Equity. Real Estate Private Equity are also called Real Estate Partnerships, Real Estate Syndicates & Real Estate Crowdfunding.
Although they are structured differently, from an investor perspective Private Equity funds are very similar to how a REIT works. The way real estate syndications work is that you invest in a company and they ultimately use your money to purchase real estate. You are then a limited partner with no further responsibility. They do the work.
There are many advantages to investing in real estate private equity.
Real Estate Syndication Provide Huge Tax Benefits
Unlike a REIT investment, these real estate partnerships have the added benefit of full tax benefits. Since you are an actual partner in the business, you get all the tax benefits directly on your tax return. So, while you are receiving quarterly distributions like a dividend, your taxes usually show a loss in the investment. It’s very similar to owning real estate directly in this regard.
Relatively Low Investment Minimum
Another huge benefit of real estate private equity is that it requires a relatively low investment. I say relatively because the minimum is usually $50,000.00 … which is no small number. And, of course, you can invest in REITs for significantly less. But, given the size of the properties you are able to invest in, it’s quite impressive over direct real estate. Imagine being able to invest in a $30 million apartment complex with hundreds of units or even multiple complexes.
A huge advantage of Real Estate Crowdfunding over directly owning real estate it that is solves another issue: diversification. Since there is such a high investment minimum with owning real estate, it becomes really hard to diversify your investments to protect yourself. With real estate private equity, I can invest in 10-20 deals for the same price of purchasing one piece of real estate directly.
Disadvantages of Real Estate Private Equity
What are the disadvantages of real private equity? Well, the biggest downside is that the deals are harder to find. Check out my video describing the disadvantages of real estate syndication for more detail. Similar to real estate if you have no experience, they can be fairly difficult to evaluate.
Real Estate Passive Investing
In summary, when evaluating a passive investment, it not only must generate income while I am able to dedicate my time to other activities. But, it also must not occupy my mind with added stress. In order for the investment to be truly passive, it must be … truly passive!
I encourage you to consider real estate as a way to diversify yourself from the general stock market. To improve your sleep factor in your overall portfolio. So that when the next stock market correction happens, you can sleep comfortably knowing that some of your money is not affected since it has a low correlation to the market.
I think all real estate is good, but some are more passive than others. And again it really has to do with what works for you.