Passive Investor

Passive Investor Definition

A passive investor is someone who has no active role in managing the asset they invest in. Under that definition, anyone who invests in the stock market is a passive investor. In real estate, however, the term “passive investor” has a more precise meaning.

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What Is a Passive Investor in Real Estate?

When people think of investing in real estate, the active investor is usually what comes to mind first.

Active real estate investors develop vacant land, manage rental properties, or seek short-term profits with fix-and-flips. Active real estate investing is a labor-intensive business model that does not appeal to everyone.

passive investor

Passive real estate investments are a way for individuals to profit from a real estate venture without participating in its day-to-day operations.

Passive Real Estate Investments

Real estate can be a powerful tool for building wealth, but not every investor has the time, skill, or interest for active investing. Fortunately, there are many options[1] for those who prefer to be a passive investor in real estate.

REITs (Real Estate Investment Trusts)

REITs are like mutual funds for real estate investors. Investors pool their money, and the trust uses those funds to finance or operate income-producing properties such as apartments, warehouses, and even cell towers. The business model is straightforward: The REIT collects rent or interest income and distributes it in dividends to shareholders.

A passive investor in REITs can choose among publicly traded trusts and private REITs. The U.S. Securities and Exchange Commission regulates the first, which are bought and sold on the exchanges, non-traded REITs that are registered with the SEC. Private REITs are not registered and are typically sold to institutional and accredited investors.

reit passive investment

REITs are popular with passive investors because they provide multiple income streams through dividends and appreciation. They are also more liquid than some other types of real estate investments. On the downside, REITs must distribute 90% of taxable income, which means the trust has less to reinvest over the long term.

Qualified Opportunity Funds

The Tax Cuts and Jobs Act of 2017[2] created the Qualified Opportunity Funds, representing a new vehicle for passive investors to invest in real estate. These funds invest in property in designated Opportunity Zones, economically distressed areas in need of revitalization.

There are multiple tax advantages for Opportunity Fund investors. Individuals who invest capital gains in an Opportunity Fund can defer capital gains taxes in the year they are realized, and eventually reduce or even eliminate the capital gains tax liability. Gains on Opportunity Fund investments are tax-free if they are held for ten years.

Opportunity Funds are not for every passive investor. Unlike REITs and other mutual funds that have daily liquidity, QOFs are illiquid. Investors must be prepared to commit for a few years.

Real Estate Crowdfunding

Crowdfunding is an online platform that lets investors pool their resources to purchase commercial real estate, apartment complexes, and other rental properties. The deal’s sponsor initiates and oversees the project and uses the crowdfunding platform to raise capital. The most well-known real estate crowdfunding platforms include Fundrise, RealtyMogul, PeerStreet, and EquityMultiple.

crowdfunding passive investor

Crowdfunding is an easy and less expensive way for a passive investor to get into real estate[3]. Anyone can open an online account, and the minimum investment is as low as $500 with some platforms.

There are some with crowdfunding, however. Investors are typically investing in one particular real estate asset as opposed to a portfolio of properties. It is a high-risk, high-reward opportunity. Crowdfunding investors also have to commit their money for a specified period, which means an illiquid investment.

Hard Money Lending

Hard money loans are often used by real estate investors who need cash to fix and flip a property. For a passive investor, providing capital for the down payment or renovations can be a good way to generate high returns.

Hard money lenders can charge significantly higher interest rates than banks and credit unions. They also recoup their money fairly quickly, since most projects are completed in under a year.

On the downside, hard money lending is risky, and there may be state regulations that prohibit hard money loans for owner-occupied properties.

Takeaways

A passive investor puts up capital for a project but assumes no role in its operations or day-to-day management. There are plenty of opportunities for a passive investor to make money in real estate. It is simply a matter of matching risk tolerance, available cash, and investment timeline to the available options.

Sources

  1. Hogan, C. (n.d.) How to Invest in Real Estate. Ramsey Solutions. Retrieved from https://www.daveramsey.com/blog/how-to-invest-in-real-estate
  2. Internal Revenue Service. (n.d.) Tax Cuts and Jobs Act: A comparison for businesses. Retrieved from https://www.irs.gov/newsroom/tax-cuts-and-jobs-act-a-comparison-for-businesses
  3. Diversyfund. (n.d.) Real Estate Crowdfunding Definition. Retrieved from https://diversyfund.com/glossary/crowdfunding-real-estate/

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