In the world of investing, there are two primary approaches you might choose to pursue: passive investment and active investment. These strategies differ in their level of involvement, risk-reward dynamics, and potential returns. When it comes to real estate syndication, understanding the difference between passive and active investment is crucial for investors looking to capitalize on this popular investment avenue.
Passive investment in real estate syndication offers the opportunity to pool resources with other investors and benefit from professional management. In contrast, active investment involves more hands-on participation in decision-making and project management of the property.
By gaining a clear understanding of these investment strategies, investors can make informed decisions and align their real estate syndication endeavors with their individual goals and preferences.
What is Passive Investment?
While there are arguments to be made for the benefits of both passive and active investment, passive investment is generally seen as more popular and accessible. Passive investment is typically thought of as a “buy and hold” process, where investors must be patient and willing to hold out through fluctuations in the value of their investments. Passive investment means being less hands-on, less reactionary, and involves fewer fees and higher tax efficiency.
Definition and Characteristics of Passive Investment
One of the chief drawbacks of active investing is the constant accrual of transaction fees and payouts to people helping to manage your active portfolio. Passive investment methods are known for avoiding both the constant fees and the volatility of more active investing methods.
The passive investment aims to build gradual wealth, meaning passive investors don’t actively respond to short-term market fluctuations. Instead of trying to outsmart and outperform the market, passive investors hold the common assumption that the market will yield positive returns over time, as long as you remain patient.
Examples of Passive Investment Vehicles
Passive investment vehicles primarily include mutual funds and syndications, where a large group of investors pools their resources to purchase a portfolio of assets.
Instead of hand-selecting each individual investment with a fund manager (as active investors do), one of the most popular forms of passive investment is to invest in an index fund. An index is a group of investments that represent and look to match the broader financial market. Index funds are pre-selected and offer an inherently diversified portfolio to investors.
When you invest in an index fund, you invest in all the companies that make up that particular index fund, meaning your investment is tied to the performance of a broad and diverse range of companies. These market index funds tend to be more stable, accrue less transaction fees, and provide, on average, a 10% annual return for investors.
Exchange Traded Fund (ETF)
While very similar to an index fund, ETFs can be bought in smaller amounts and are generally more flexible when it comes to buying and selling investments. ETFs can be purchased and traded at any point, much like a regular stock, as opposed to index funds, which are priced only after the market has closed for the day.
Syndications are a type of passive investment in the real estate market. Syndications allow investors to pool their resources and acquire expensive multi-family or multi-use units that investors could not acquire on their own. Syndications can be a valuable way to diversify a portfolio, as they provide a specific resource that will be in need regardless of how the market changes.
Benefits of Passive Investment
Passive investment is typically seen as:
- Good for long-term investment: Passive investing is commonly referred to as a buy-and-hold process that requires investors to hold over a long period of time.
- Hands-off and less complex: Instead of constantly trading individual stock options in an effort to outsmart the market, passive investors typically invest in a group option such as an index, exchange-traded fund, or syndication where decision-making is less flexible but more hands-off.
- Lower costs and better returns: Active investment can rack up transactional fees fast, which is why passive investment vehicles strive to reduce those fees by limiting trading fees. You’ll also typically pay less in capital gains taxes and outperform active investment in the long run. In the last ten years, only a quarter of active funds have beat out passive funds in terms of profit yield.
What is Active Investment?
Active investment is generally riskier than passive avenues, but in contrast, it can yield high short-term gains. Active investment requires investors to be quite hands-on and knowledgeable about their chosen investment route. It can be hard to “beat the market,” a concept that is one of the foundations of active investment and refers to the ability to gain returns at a rate higher than the market average, and humans aren’t great predictors of when to buy and sell.
Definition and Characteristics of Active Investment
Active investment is often defined by a hands-on approach, increased flexibility, higher risk with the possibility of higher reward, and tends to have higher fees associated with the investment. In the stock market, this means relying on human analysts and portfolio managers to help decide what to purchase, when to purchase, and what the best time to sell is. In real estate, this means taking an active role in the acquisition and management of properties. Both allow the investor more control and flexibility and a higher return on investment, but the fees associated with active investment can be high enough to negate any returns.
Examples of Active Investment Strategies
Amongst the many active investment strategies someone can take on, stock picking and real estate development are two of the most popular.
Stock picking refers to the process when an investor or analyst studies factors to determine which stocks to invest in and when to buy and sell. There are two main types of stock picking: top-down and bottom-up. Top-down involves looking at the big picture and larger economic influences, while bottom-up involves looking at specific company factors such as the goods and services they sell, supply and demand for their goods, and company financials.
Real Estate Development
Active investors in real estate development take on the majority of the labor involved with property acquisition, finding investors, development, renovations and repairs, and property management. This can take the form of different forms of property investment, from house-flipping to larger-scale property developments.
Benefits of Active Investment
- Greater control and involvement in investment decisions: With active investment, you can make more decisions about what you invest in. For example, passive investment strategies such as index funds require you to invest in the entire funds’ collection, whereas active investment allows you to pick and choose which stock options you buy into.
- Potential for higher returns through skillful decision-making: The right choices in active investing can yield high returns as investors beat the market and receive significant short-term returns.
- Flexibility to adapt to market conditions: Passive investing requires investors to be patient and ride out the fluctuations in the market. Active investment allows investors to quickly make decisions about their assets and respond to any volatility in the market.
Real Estate Syndication as a Passive Investment
While there are some great options for passive investment, one of the most valuable is real estate syndication, which allows investors to pool resources and time in order to invest in expensive multi-unit real estate purchases that would otherwise be too expensive or time-consuming to take on alone.
Introduction to Real Estate Syndication as a Passive Investment Strategy
Investing in real estate is not only expensive, but it also requires a strong knowledge of the legal and financial side of the industry. This is where real estate syndications are particularly valuable, as they connect investors to sponsors (also known as general partners) who take on the research as well as the legal and financial decision-making.
Sponsors do the groundwork of finding the properties, managing cash flow, and are responsible for the day-to-day management of the property itself. On the other hand, investors are the primary source of capital for the property, and they play a passive role in acquiring and managing the properties themselves.
Real estate syndications typically focus on multi-family real-estate opportunities. In simple terms, this means residential buildings with more than one family unit, such as apartments, condos, and townhouses. This allows investors to receive profits in the form of rent from many individuals instead of just one and typically yields higher returns on investment than single-dwelling properties.
Benefits of Real Estate Syndication as a Passive Investment
There are many benefits to choosing a real estate syndication as a passive investment opportunity:
- Access to larger-scale real estate projects: Multi-family real estate is costly and not accessible to most individuals. While a multi-family real estate syndication is still a large investment, it is significantly less expensive than it would be to purchase alone. This allows investors to get in on much larger-scale projects.
- Professional management and expertise: One of the main benefits of a real estate syndication is the expertise, guidance, and knowledge contributed by sponsors.
- Diversification of investment portfolio: Because syndications make it easier to access expensive multi-family units, it allows investors to diversify their portfolio in ways they wouldn’t otherwise be able to do financially.
- Potential for steady cash flow and long-term appreciation: Real estate syndication typically follows a process of acquisition and value-add, allowing investors to receive regular cash returns as the value of the property increases, and rent is acquired over time.
Key Factors to Consider When Choosing Passive or Active Investment
When choosing between passive and active investment, one of the most important things to do is clearly define your investment goals and objectives. By understanding what you hope to gain from investing, your expectations for risk, and the time you hope to spend managing your portfolio, you can make a more informed decision about which investment route is right for you.
Risk Tolerance and Investment Objectives
Before choosing to make either passive or active investments, it’s essential to assess your own risk tolerance. Investments are never a guarantee, so it’s vital that you make decisions about your investment that are in line with your financial goals and objectives.
Time Commitment and Available Resources
Active and passive investment strategies require vastly different time commitments. While some people will appreciate the increased flexibility and control of active investments, others will find that they consume too much of their time and resources and can result in overall losses.
Understanding Market Conditions and Investment Opportunities
Passive vs. active investment strategies may be better at certain times depending on market conditions and the current investment opportunities available.
Ultimately, there is no one-size-fits-all approach to an investment strategy, but for most investors, a passive strategy is going to be a safer bet that yields higher long-term returns. For some, a combination of passive and active may be a successful strategy, while others may go all in on more active opportunities.
With clearly defined goals, an understanding of your availability and resources, and a desire to grow financially, you can find an investment strategy that works for you.