What Is Passive Real Estate Investing And How Does It Work? (2024)

FAQs

What Is Passive Real Estate Investing And How Does It Work? ›

Hands-off approach: When you invest passively, you put investment decisions in someone else's hands. If you invest in a real estate fund, the person running the fund will select all investments. If you have remote ownership of a property, someone else is managing it – and they may or may not be doing a great job.

Passive real estate investing is a strategy whereby an investor puts money into a real estate venture but isn't actively involved in the day-to-day management or decision-making of the property or properties.

Passive investing is a long-term investment strategy that focuses on buying and holding investments for the long term. Its goal is to build wealth gradually over time by buying and holding a diverse portfolio of investments and relying on the market to provide positive returns over time.

If you choose to be a real estate investor, you could own one or more properties, or pool your money with other investors into a fund that includes several properties. You earn money when properties in the fund are sold. You may also earn income from the rental of the property while holding the asset.

Passive real estate investing can take many forms, including real estate investment trusts (REITs), crowdfunding, syndications, and more, offering investors flexibility. Many passive real estate investments, such as crowdfunding and REITs, allow entry at lower capital outlays than traditional property ownership.

There are several ways to be a passive investor. Two common ways are to buy index funds or ETFs. Both are types of mutual funds — investments that use money from investors to buy a range of assets. As an investor in the fund, you earn any returns.

You can create additional residual income through investments such as real estate. By investing in real estate, you will create monthly cash flow that will build your residual income over time. The one-time payment that an investment requires will be returned to you over time as the investment generates income.

Critics of passive investing say funds that simply track an index will always underperform the market when costs are taken into account. In contrast, active managers can potentially deliver market-beating returns by carefully choosing the stocks they hold.

Passively managed funds include passive index funds, exchange-traded funds (ETFs), and Fund of funds investing in ETFs. These funds follow a benchmark and aim to deliver returns in tandem with the benchmark, subject to expense ratio and tracking error.

Low cost – they track an index which means there's no research costs for choosing investments. They also aim to make less purchases and sales, reducing dealing charges. Transparency – because they're trying to track a particular index, it's often clear what you're investing in if you know what's in the index.

What is passive rental income? ›

The IRS considers a rental activity to be passive if real estate is used by tenants and rental income (or expected rental income) is received mainly for the use of the property. In other words, owning a rental property and collecting rental income is considered passive and not active in most cases.

Rental property is considered passive income because it generates income without requiring you to actively work for it. When you own a rental property, you can earn passive income from the rent that tenants pay.

For many individual investors, it can take years — or even decades — before they start seeing true wealth. The average residential property generates around 10.6% in annual returns, according to Forbes, while commercial properties see returns closer to 9.5%.

Typically, passive income is subject to a taxpayer's usual marginal tax rate, which is based on their tax bracket. But taxpayers whose modified adjusted gross income is above a certain threshold may also be subject to the Net Investment Income Tax (NIIT).

Passive portfolios typically include a few different types of investments. Principal among these are index funds, mutual funds and exchange-traded funds (ETFs). Rather than select single securities like stocks or bonds, these funds seek to diversify across a number of individual holdings.

Q: What is the difference between active and passive real estate investment? A: Active investment is a hands-on role where you'll manage the property directly. Passive investment is a backseat approach; you'll put money into a syndication or REIT and spend much less time on day-to-day operations.

There is no need to select and monitor individual managers, or chose among investment themes. However, passive investing is subject to total market risk. Index funds track the entire market, so when the overall stock market or bond prices fall, so do index funds. Another risk is the lack of flexibility.

It's easiest to live off of passive income if you live in a low cost-of-living area. To live off of financial investment and cash-equivalent income, you'll need a larger amount of money. To earn $30,000 per year, you'll need $600,000 invested at 5% per year.

The 2% rule is a rule of thumb that determines how much rental income a property should theoretically be able to generate. Following the 2% rule, an investor can expect to realize a positive cash flow from a rental property if the monthly rent is at least 2% of the purchase price.