Active or passive real estate investing? How to decide?
Updated: Dec 20, 2019
As a serial entrepreneur I have lived and moved across 17 cities while I launched and grew my businesses. When my wife and I had no kids, we rented and it was easy to pack up and move. When our oldest son was born, we bought our first house in San Jose, CA. Since then our family has grown and we now have three wonderful boys. My wife and I quickly discovered, with three boys, it was cheaper to buy a house whenever we moved. It gave the boys space to run around while saving us the stress of worrying about security deposits. Over fifteen years we bought properties in CA, WA, IL and TX as our personal residences and then ended up renting some of them instead of selling them when we moved. Over time we also added some investment homes to our portfolio.
It was initially fun to put together this portfolio of properties that we actively managed. We felt we were building wealth and were going to come out ahead over the long term.
However as we grew busier with our careers and raising the boys, time became scarce. Maintenance issues with pipes freezing and bursting, appliances breaking down, plumbing issues, garage doors getting stuck, and floors and carpets needing to be replaced became harder to manage across state lines. Murphy's law also ensured most of these issues happened when we were on vacations and were limited in out ability to react. We ended up getting property managers for all our investment properties.
I've now realized that actively managing real estate investments is terrible advice for all but a lucky few. There are multiple reasons for this:
It most likely won’t generate the income you expect. Rents may go up but property management fees, insurance and maintenance expenses go up faster. And you will have vacancies as tenants move in and out when you are generating no income.
It’s hard to generate a compelling return after you account for all the brokerage fees and expenses. And if you consider a 10+ year investment horizon remember your property is 10 years older too and you will need to replace the HVAC, water heater etc..
No matter what Redfin or Zillow tell you about your current home value and how much it has appreciated you will realize that when you actually list and sell you will be underwhelmed.Real estate is inherently illiquid, so you can’t necessarily sell it when you want and as your property sits on the market for a few months with no income you will feel the burden.
You are personally guaranteeing each mortgage and at the end of the day have increased risk exposure
Before you buy a rental property as an investment, consider the above reasons for why you’re unlikely to come out ahead.
I've still kept most of my properties but my strategy has changed to now harvesting tax losses from these properties as my primary strategy.
That's why I've shifted my investment focus to multi-family commercial real estate over the last few years and recommend a passive investment strategy in multi family real estate to my friends and family.
Here are the benefits I've found from this investment class:
Better Returns - You will make annual cash returns of 6%+. We have some properties that generate 11% annual cash returns. That is real tangible cash in your pocket. We also see ~20% IRR on our deals, which is a very good return.
Reduced Volatility - Since we invest in large complexes with 100+ units with occupancy rates > 90% you will see much less volatility as tenants move in and out.
Reduced Risk - You have reduced risk exposure since mortgages on multi family properties are non-recourse debt, which means you are not personally guaranteeing the loan. In addition, since we have access to some of the nations best underwriters we are able to get very favorable terms that we pass along.
Shorter Horizon - Most multi family investments are made with a 3-5 year horizon compared to 7-10 for single family investments.
Passive Management - You only need to invest the capital and collect the returns. We have active property management for each of our properties and also onsite maintenance 24x7 that is able to detect and fix issues.
Contact us if you are interested in learning more.