Active vs. Passive Multifamily Investing: Which Is Best for Me?
Different investment styles suit different people. Read our comparison and determine your best way forward.
- What Are Active and Passive Investing?
- Active Investing
- Passive Investing
- Which Type of Investing Is Right for Me?
- Initial Capital Requirements
- Active Investing
- Passive Investing
- Decision Making and Control
- Active Investing
- Passive Investing
- Time Commitments
- Active Investing
- Passive Investing
- Risk Profiles: What’s at Stake?
- Risk Factors in Active Investing
- Market Downturns
- Unforeseen Expenses
- Mitigating Risks in Passive Investing
- Diversification
- Professional Management Teams
- Wrapping Things Up
- Get Financing
New to multifamily investing? You’ve no doubt thought about whether active or passive investing is the right path for you.
And I’ll get to that in a second. But, first, let’s go to Japan. (It’s going to make sense in a minute.)
I decided to move to Japan in 2010 to teach English.
(If this isn't your cup of green tea, just move to the next heading to learn about active and passive investing. I swear I won’t be offended. Much.)
I filled in the application, did a couple rounds of interviews, and got my start date in a city I’d never heard of.
My then-employer told me they would be handling my immigration visa, finding me an apartment to rent, and even opening my bank account.
That, I thought, was a lot of trust to place in an employer. But (here comes the connection I promised), it’s not so different from being a passive multifamily investor.
What Are Active and Passive Investing?
Just like setting foot into a new land, multifamily investing is an alien landscape. Doubly so if it’s your first time. New rules, new metrics to examine, new risks and opportunities.
Active Investing
Active investing is a lot of work. You need to understand your market, have a clearly defined investment strategy, and be prepared to adapt to unforeseen changes. You’re on the hook for all of it, after all.
At the same time, you’ve potentially got a ton of investment upside. If you’re doing, say, a fix and flip, the costs may be high, but do it well and you’ll potentially get a huge return on investment.
Passive Investing
Passive investing is, well, passive. You don’t need to know too much about the rules (though you’d be best served to consult with a CPA and understand whether or not you qualify as an accredited investor).
Investing passively is a hands-off approach that still can net you as an investor a very healthy return — just at a smaller scale in most cases. On the other hand, forget about having to deal with any of the more challenging aspects of multifamily properties, whether that’s property management issues or renovation work. Your sponsor will take care of it all, as it's her or his role in the deal.
Now, passive investing isn’t totally hands off — especially at the inception stage. You’ll need to understand the market you’re investing in and have confidence in the syndicator you’ll work with. You’ll likely be investing $50,000 at a minimum to get started, so you’ve got to be careful with your diligence.
Thankfully, today most experienced syndicators use one of a number of fantastic syndication platforms which provide you with key details on the deal, so you know exactly what you're getting into. Still, it always pays to do some homework on your own.
Which Type of Investing Is Right for Me?
That depends greatly on a variety of factors. Let’s explore each of them here, and how they work for active versus passive investing situations.
Initial Capital Requirements
Active Investing
Active investing almost always requires significantly more capital to invest. Whether you’re buying a modern duplex or a dated building, those costs are yours to bear alone, apart from any financing you’ll utilize.
It’s not just the down payment, either. If you plan to execute any renovation plans or expand units, that’s all coming from you (again, plus any renovation loan you might utilize). Note that also unexpected deferred maintenance costs could jump out of nowhere.
Passive Investing
For passive investors, the initial capital outlay is spread out across all participating investors. If you invest $100,000 as a group of 30 investors, you know exactly how much you’re putting in. Any capital improvements will be covered as part of the investment strategy you’ve signed up for.
Exceptions do happen, of course. There’s always the possibility of a capital call, when a syndicator asks for additional funding from investors to cover unexpected expenses.
Decision Making and Control
Active Investing
Buying a property on your own is particularly liberating if you have a good head for strategy and like to be in control of your investment. You’re in the driver seat, and you get to decide what to do (or not do) with your apartment building.
Passive Investing
If you’re one of many investors in a syndication, you’ll have to learn to sit back and not be in control. This may sound scary, but that’s why it’s crucial to choose an experienced syndicator you trust and can rely on to make the best decisions for your investment.
Time Commitments
Active Investing
Because you need to be so hands-on with an active investment, they generally require a greater deal of time and effort to see through successfully. Even if you contract an experienced property management company, you’ll need to make tough decisions on how your property should operate.
If you have a demanding career, it can be a real challenge to balance the two. On the other hand, if you’re willing to dedicate your time and energy to your investments, it can be a lucrative way to build financial independence.
Passive Investing
After you’ve made the decision to invest in a property, you’ll rarely need to commit much time to the investment. After all, your syndicator and any other professionals are handling the day-to-day and even longer-term operations of the asset. It’s a good idea to review regular reports on the property to ensure everything is going according to plan, but that aside, passive investments don’t require much time.
Risk Profiles: What’s at Stake?
No matter what kind of investing you choose to do, there’s risk involved. Still, there are ways to counteract or prepare for these risks so they don’t take you or your investment by surprise.
Risk Factors in Active Investing
Market Downturns
Multifamily markets fluctuate just like any other. If you’re going it alone, you’ll need to keep your eye on market indicators and metrics, not to mention the performance of your own asset. If you’re seeing an increase in construction, for example, it could lead to decreased occupancy across the market — which could lead to empty apartments in your building. Make sure you have a plan in place so a decrease in property revenue won’t impact your ability to pay your bills, cover repairs, and service debt.
Unforeseen Expenses
I already mentioned deferred maintenance — and that’s an aspect of it — but if there’s one thing about unforeseen expenses, it’s that they’re nearly certain to occur. You can’t plan for everything, after all. If you don’t have reserves on hand, though, this could significantly impact the profitability of your investment.
Mitigating Risks in Passive Investing
Diversification
Because you’re likely putting less capital into the deal, you may have the ability to diversify your portfolio a bit more. Consider an active investor with $500,000 invested in, say, Austin. Contrast this with a passive investor with 10 $50,000 investments spread across different cities and states. Diversification is key to weathering market swings.
Professional Management Teams
When you’re a passive investor, you’re placing trust in a team of seasoned professionals to manage the property. That means you’ll have experts making decisions and handling the operations of the asset. This is essential during a downturn, but it also helps boost the profitability of your property when things are going great, too. Just remember that you need to have confidence in your syndicator and management team — that’s the main risk here.
Wrapping Things Up
Let’s take a quick trip back to Japan.
My experience there was mostly positive. My employer did, indeed, secure my accommodation, got me an employment visa, and they even let me use interpreters to communicate with the school leadership I occasionally worked with.
This is why it’s important whenever you give up control — whether that’s for a multifamily investment or a career move — you conduct serious research on the opportunity.
If you’re investing as part of a syndication, it’s a good idea to look at the syndicator’s track record. That could include anything from asking probing questions about previous capital calls to requesting detailed information on how investor updates (and, critically, cash distributions!) are handled.