Many investors are turned off by real estate because they do not have the time or inclination to become landlords and property managers, both of which are in fact, a career in themselves. If the investor is a rehabber or wholesaler, real estate becomes more of a business rather than an investment.
Many successful real estate “investors” are actually real estate “operators” in the real estate business. Fortunately, there are other ways for passive investors to enjoy many of the secure and inflation proof benefits of real estate investing without the hassle.
Active participation in real estate investing has many advantages. Middlemen fees, charged by syndicators, brokers, property managers and asset managers can be eliminated, possibly resulting in a higher rate of return. Further, you as the investor make all decisions; for better or worse the bottom line responsibility is yours.
Also, the active, direct investor can make the decision to sell whenever he wants out (assuming that a market exists for his property at a price sufficient to pay off all liens and encumbrances).
Passive investment in real estate is the flip side of the coin, offering many advantages of its own. Property or mortgage assets are selected by professional real estate investment managers, who spend full time investing, analyzing and managing real property. Often, these professionals can negotiate lower prices than you would be able to on your own.
Additionally, when a number of individual investor's money is pooled, the passive investor is able to own a share of property much larger, safer, more profitable, and of a better investment class than the active investor operating with much less capital.
Most real estate is purchased with a mortgage note for a large part of the purchase price. While the use of leverage has many advantages, the individual investor would most likely have to personally guarantee the note, putting his other assets at risk. As a passive investor, the limited partner or owner of shares in a Real Estate Investment Trust would have no liability exposure over the amount of original investment.
The direct, active investor would likely be unable to diversify his portfolio of properties. With ownership of only 2, 3 or 4 properties the investor's capital can be easily damaged or wiped out by an isolated problem at only one of his properties.
The passive investor would likely own a small share of a large diversified portfolio of properties, thereby lowering risk significantly through diversification. With portfolios of 20, 30 or more properties, the problems of any one or two will not significantly hurt the performance of the portfolio as a whole.
Types of Passive Real Estate Investments
Real Estate Investment Trusts
REITs are companies that own, manage and operate income producing real estate. They are organized so that the income produced is taxed only once, at the investor level. By law, REITs must pay at least 90% of their net income as dividends to their shareholders. Hence REITs are high yield vehicles that also offer a chance for capital appreciation.
There are currently about 180 publicly traded REITs whose shares are listed on the NYSE, ASE or NASDAQ. REITs specialize by property type (apartments, office buildings, malls, warehouses, hotels, etc.) and by region. Investors can expect dividend yields in the 5-9 % range, ownership in high quality real property, professional management, and a decent chance for long term capital appreciation.
Real Estate Mutual Funds
There are over 100 Real Estate Mutual Funds. Most invest in a select portfolio of REITs. Others invest in both REITs and other publicly traded companies involved in real estate ownership and real estate development. Real estate mutual funds offer diversification, professional management and high dividend yields. Unfortunately, the investor ends up paying two levels of management fees and expenses; one set of fees to the REIT management and an additional management fee of 1-2% to the manager of the mutual fund.
Real Estate Limited Partnerships
Limited Partnerships are a way to invest in real estate, without incurring a liability beyond the amount of your investment. However, an investor is still able to enjoy the benefits of appreciation and tax deductions for the total value of the property. LPs can be used by landlords and developers to buy, build or rehabilitate rental housing projects using other people's money. Because of the high degree of risk involved, investors in Real Estate Limited Partnerships expect to earn 15% + annually on their invested capital. Real Estate Limited Partnerships allow centralization of management, through the general partner.
They allow sponsors/developers to maintain control of their projects while raising new equity. The terms of the partnership agreement, governing the on-going relationship, are set jointly by the general and limited partner(s). Once the partnership is established, the general partner makes all day to day operating decisions. Limited partner(s) may only take drastic action if the general partner defaults on the terms of the partnership agreement or is grossly negligent, both events that can lead to removal of the general partner. The LPs come in all shapes and sizes, some are public funds with thousands of limited partners, others are private funds with as few as 3 or 4 friends investing $25,000 each.
So investing in real estate has many options and risk tolerances. You don't always have to be involved in the “operating” side of things and can enjoy decent returns using various passive investing avenues.