Throughout my career in investments, particularly with real estate, I found many investors wanted to buy and operate real estate themselves. This was for many reasons, they thought they could earn more by saving on property management fees, maintenance and purchases. Others, wanted to tell their friends, “I own an apartment in Miami.” And, yet others actually wanted to use that apartment in Miami and rent it out short-term.
In every case, they didn’t realize the work involved in maintaining a property, particularly if they are absentee owners. It is even more difficult if you own several properties. They also didn’t realize that if they lost the tenant, they would lose 100% of their revenue until it was rented, they would have to pay a realtor to get it rented, etc..
Some people actually like this. I know a property owner with about 100 single family units and he manages them all himself. Most people, however, have full-time jobs and don’t have much time for managing real estate.
Passive investing gives people a way to invest their money without having to dedicate lots of time to managing that investment. That is, after all, how the stock market works. People buy stocks in companies that are managed by thousands of people to make money and grow the company. The stockholder just sits back and reaps the benefits. However, because there are so many people in the stock market, and so many large institutions operating with almost unlimited capital, there are few opportunities in the stock market, particularly for cash flow. The opportunities are arbitraged out of the market.
Active Investing
- Requires knowledge of the business or asset.
- Dedicate sufficient time to running the business.
- Dealing with problems that always come up.
- Managing the people involved in running the business.
- Sacrificing evenings and weekends.
- Time / business conflict with existing employer.
Passive Investing
Why should I invest passively rather than buy the property myself?
- Complex asset classes can bring people with better expertise and who are more efficiency.
- Simple asset classes, such as single-family homes, there isn’t much difference.
- For two hundred unit and greater multifamily real estate, an operator adds tremendous value.
- Diversification among geography, tenants, products, operators and other aspects.
- The sponsor is the only party to incur credit and liability risk. The passive investor is not subject to these liabilities.
- Allows investors to rely on highly sophisticated operators, which attracts many high-caliber people to manage the business.
- In many cases a high-caliber team is able to get better results that overcome the management fees charged.
When I worked as a CFO for a real estate, private equity firm, we averaged an IRR of 28% over a period of eight years for our investors. We had a team of 120 people looking after our investors’ money and our properties. The team had 11 department heads which were experienced experts in their respective departments. Busy people who work full time will not be able to generate returns like that consistently, nor can they manage all the people required to do this.
Ironically, it takes work to generate passive income. Investing with an experienced operator will remove some of that burden from the investor.
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