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Even people with a lukewarm interest in finance are familiar with the concept of passive income. It’s an enticing prospect: earn money by simply doing nothing. Who’s ears would perk up at the suggestion that they can generate passive income just by buying and holding property? But, how realistic of an idea is it, really?
‘Passive income’ from commercial real estate investments is more a myth than truth when you break it down. When you account for all the hard work of finding potential properties to invest in, developing those properties in a way they are desirable to tenants, drafting leases and contracts, and day-to-day management of affairs, the truth begins to emerge—
There is nothing ‘passive’ about buying, developing, managing, and selling real estate. But there are ways an investor can profit from real estate without doing the labor. They just have to be comfortable ceding control over their investment decisions to the companies and businesses that do all the hard work.
That’s why serious investors shouldn’t be concerned about ‘passive income,’ but instead focus on what type of investor they want to be—active or passive.
Passive Vs. Active Investing
One way to think about the difference between passive and active investing is to consider the role of the investor in the process of generating revenue.
Active Investors
Active investors are very involved in the process. They have a say in choosing, developing, marketing, and managing the properties they invest in. Active investors don’t necessarily have to own the entire property, but they will usually have a share of ownership.
Active investing requires the attention, focus, and expertise expected of a full-time employee—it is, in fact, a full-time job. To do it effectively at scale requires entire departments of full-time employees devoted to the many aspects of commercial real estate investing.
Because there are already many companies handling the business of commercial real estate investing, regular investors who are simply looking for a place to grow their wealth find it more cost-effective to invest in those companies rather than invest directly in real estate themselves.
This brings us to passive investing.
Passive Investors
Passive isn’t meant to be a pejorative description. Instead, it is simply meant to discuss the investor’s role in making decisions on the investment properties.
Being a passive investor allows a person to come as close to ‘passive income’ generation as possible. They are fronting capital with the expectation of decent ROI, but their role in the actual work stops shortly after handing over their capital. The downside here is that they have little say in how their money is used—beyond the initial choice to invest it, hence the passivity.
Passive Investing Options to Generate ‘Passive Income’
Passive investors have several options when trying to get exposure to real estate. There are REITs, REIT ETFs, and crowdfunded real estate investment platforms, all of which are described further below:
REITs
REIT stands for real estate investment trust. REITs research, purchase, develop, manage and sell real estate properties. They can be privately traded or publicly traded on exchanges and, as a result, function as a type of stock. Investors purchase shares of the REIT and see returns in the form of dividends and share appreciation.
REIT ETFs
REIT ETFs are ETFs—or exchange-traded funds—that purchase shares in REITs. Confused? It’s ok. Let’s break it down further—ETFs are a type of unique investment fund.
Investment funds are professionally managed pools of investor capital used to purchase various types of securities, from gold and bonds to stocks and debts. ETFs are unique from other funds—like mutual funds, pension funds, and hedge funds—because ETFs are traded on exchanges like stocks.
REITs vs. REIT ETFs
There isn’t a practical difference between REITs and REIT ETFs for the average investor. Both are traded like stocks on public exchanges. Both are considered indirect, with REIT ETFs being two degrees removed from actual real estate compared to REITs being only one degree removed.
Crowdfunding Real Estate Investment Platforms
This relatively new method of investing in real estate takes advantage of the internet and communications technology to connect investors with investment opportunities directly. Each crowdfunding platform has a unique spin on the idea, with some only being open to high net worth individuals that can afford the steep investment minimums and others being open to anyone with internet access and ten dollars.
In many ways, this option offers a unique blend of passive and active investing. Some crowdfunding platforms allow investors to choose individual properties to invest in, giving them more of an active role in how their capital is used.
Which Type of Investor Do You Want To Be?
By now, it’s clear that when people say ‘passive income’, they are really talking about passive investing. Passive investing is the way to go if you don’t have the time and energy to devote to extensive market research, property acquisition, property development, and the many other tasks associated with active real estate investing. Active investing gives the individual greater autonomy in investing decisions but at the cost of much more responsibility.
About the Author
Roni Davis is a writer, blogger, and legal assistant operating out of the greater Philadelphia area.
Photo by RODNAE Productions from Pexels