Successful people who want to preserve and grow their wealth eventually find their way into the real estate investment world, regardless of how they earned their money in the first place.
As Franklin Roosevelt once said, “Real estate cannot be lost or stolen, nor can it be carried away. Purchased with common sense, paid for in full, and managed with reasonable care, it is about the safest investment in the world.”
It’s no wonder, then, that this instrument that provides both stability and growth is so attractive to people from all walks of life.
The problem is that the real estate industry is saturated with all kinds of advice that might not be appropriate for everyone.
Someone earning well from their salaried job or business does not need to take the same path into the real estate world as a young, ambitious, and broke kid out of college.
Reinventing the wheel and buying a duplex you plan to self manage is probably not the wisest use of your money when you are a high earner or have a high net worth.
Avoiding the Crowd
The truth is, you have more options available to you than the “no money down” crowd and your strategy should reflect that.
Unfortunately, many high net worth individuals are unaware of the fact that they can receive very attractive returns from real estate in the form of a completely passive investment.
By investing in real estate syndications, you can get the benefits of investing in real estate without all of the headaches.
Real estate syndications are offered by real estate investment companies that specialize in raising capital and asset management.
The members of these companies are called the general partners of the syndication and they are the ones who do all of the work for you.
They find the deals, negotiate the purchase price, conduct due diligence, engage and hire the property manager, manage the asset, and negotiate the exit via a sale or refinance at the end of the hold period. We discussed multifamily syndications in-depth in our What is a Real Estate Syndication for Multifamily Investing article.
Don't Get the Wrong Idea
Now, I don’t want you to get the wrong idea with the word lazy.
Perhaps more accurately, this is the “lazier” route – there’s far less responsibility on your shoulders as a passive investor, but there’s obviously still some work involved in finding real estate investment companies that syndicate deals you are interested in, a bit like a lower intensity version of how an active investor finds the deals themselves.
From there, however, the work involved for the passive investor is obviously reduced quite a bit:
Your main responsibilities are deciding whether you believe the investment offerings you receive from syndicators are worthy of your time and money and then staying in communication with the general partners for updates on the asset’s performance during the hold period.
In order to do so, you need to verify the financial projections presented in the offering memorandum, as well as make sure the general partners are performing thorough due diligence once under contract.
Verifying the financial projections can be done by verifying how realistic the rents, expense ratio, cap rate, annual rental increases, and interest rate on the debt are for the market the offering is located in.
In our 10 Key Metrics Real Estate Investors Care About article, we gave an overview and explanation of some of the metrics you’ll be presented with in a typical offering.
We also discussed how to perform due diligence for large multifamily purchases in our Due Diligence For Multifamily Investing Explained article.
Make sure the general partners are following these practices. If they aren’t conducting thorough due diligence, that’s usually a bad omen for how they will behave with your money moving forward.
In today’s article, we’re going to focus on the differences between investing passively in a real estate syndication as opposed to buying real estate yourself as an “active” investor.
We’ll focus on multi-family properties as they are the cornerstone of our own investment strategy, as well as one of the most popular property types for real estate syndication.
1. What is your goal in entering the real estate industry?
Are you trying to supplement and grow your existing sources of income, or are you looking to switch careers?
Investing actively is a full time job. You might know people who juggle a rental portfolio with a full time career, but trying asking them how easy it is.
Then try asking them if they think they could find better deals and improve their asset management systems if they were able to focus on their real estate investments full time.
The truth is, that approach can only take you so far, and with scale, you’ll likely need to quit your salaried job or ramp down your other businesses in order to responsibly manage your investments.
Obviously, this is a pretty drastic change for many people who are already earning well in their current position and aren’t looking for a career change.
This is NOT a Hobby
This is not a hobby and needs to be treated as such, especially if you have investors involved in your deals.
They expect full time effort from you. Passive investment provides a nice middle ground where you can still enjoy regular cash flow distributions while offsetting your tax liability through depreciation, one of the many benefits of owning real estate.
We discussed this topic in depth in our Benefits of Depreciation & Cost Segregation Studies for Real Estate Investors Explained article.
2. Team Management:
Active investing requires you to assemble a team of professionals that help your business run smoothly.
You’ll need a skilled CPA with experience in real estate and raising capital for real estate.
You will need a securities attorney to properly draft the documents you need to form a syndicate and comply with SEC regulations (more on this below).
You will need to identify and build relationships with trusted and experienced property management companies in every market you’re targeting and vet them heavily before bringing them on board.
The property manager is a key pillar in your operation and a lot of time and attention needs to be put into selecting a good manager and then “managing the manager” during the hold period.
Your role as the operator and general partner also requires a variety of skills and is very difficult to manage as a single person.
You will likely need to partner with other active investors with complementary skills to have a realistic shot at success in this industry.
Our company has a team of seven full time members in order to tackle the disparate and seemingly unending tasks we need to perform on a daily basis.
Ditch the Team?
As a passive investor, you have no team to manage.
Your only similar task is in nurturing relationships with real estate investment companies that offer syndication opportunities that make sense for your investment strategy.
3. Sourcing Deals:
As an active investor, you need to have constant deal flow in order to cut through the fluff.
If you’re investing responsibly, you’ll turn down the vast majority of deals that get shopped to you and will need a robust network of brokers that you maintain contact with in order to ensure the rare good deals do not slip through the cracks.
Our company actually uses a CRM system for this because of the amount of people you might need to keep track of when you are investing in several markets at once.
Every good broker will have people vying for their good listings and you’ll need to both demonstrate your expertise in the field by giving them a clear idea of what kind of assets you’re looking for, as well as stay on their mind through regular communication.
4. The Pros and Cons of Leadership:
Do you enjoy managing teams, like we discussed above?
Are you okay with, or perhaps even enjoy the feeling of responsibility and people depending on you?
Do you enjoy building and operating asset management systems and providing your investors with detailed and regular reporting?
As an active real estate investor raising capital you are the leader of an organization and need to act accordingly.
Your investors, lenders, tenants, contractors, managers, and staff all depend on you day in and day out to perform at a high level.
This might be a heavy burden for some people who prefer to take the role of a passive investor. For those who are up for the challenge, active real estate investment has the highest potential for returns.
Just keep in mind that being an active real estate investor has a very steep learning curve and can take years of experience and constant research to achieve lasting success.
Complying with Regulations
If you are raising money as an active investor, you need to comply with all SEC regulations involved with selling a security.
For the majority of real estate syndications, will need to file a form D notice with the SEC that has specific guidelines for how and to whom you can present your offering.
Your securities attorney will also need to draft a private placement memorandum for each offering, which can cost up to $10,000 or more, depending on their rates.
We discuss this topic in more detail in our Private Placement Memorandum (PPM) Operating Agreement, and Rule 506 For Real Estate Syndication Explained article.
Always Use Caution…
As the active investor or general partner in a real estate syndication, you need to be extremely careful that you are closely abiding by the letter of the law. Failing to do so can and will have costly consequences sooner or later.
As a passive investor, your main point of compliance with regulations would be verifying that you are an accredited investor through a third party verification service in the event that you decide to invest in a 506-c offering.
We explained who qualifies as an accredited investor in our What is a Real Estate Syndication for Multifamily Investing article.
6. Why not try both?
Many people, including many of our own investors, begin researching real estate with the goal of being active investors themselves.
This seems fun and exciting at first, but they quickly realize upon further research the depth of commitment involved with active investing and are unsure of how to proceed.
In their research, they eventually stumble upon passive real estate investing and decide it is more appropriate for their lifestyle and goals.
Another common type of investor we’ve worked with are people who are in the real estate industry or are working towards someday becoming a full time real estate investor.
They want to learn more about syndicating large purchases while earning some money doing so.
A Stepping Stone
Even if you intend on someday being an operator yourself, investing passively might be a great stepping stone to get there.
You can see how established companies conduct their offerings, what type of deals they are presenting, and what sort of returns they are providing to their investors.
The interesting thing is that active investors that syndicate real estate purchases, ourselves included, often passively invest with other companies on the side to diversify and continually roll their capital into new investments.
Like we said earlier, a responsible investor will be turning down most deals that are sent to them and they are working full time to find that diamond in the rough.
No one knows better than another active investor how much time and effort is put into this.
The point is, don’t feel discouraged if you decide that active investing is not the right fit for you, or perhaps you’re not ready yet.
You’ll be surprised at how much you’ll learn (and how much passive money you can make!) when you invest in a real estate syndication.