Real estate is a great way to create wealth. In fact, real estate is the primary way that most millionaires in the United States got that way.
However, active methods of investing in real estate, such as owning and managing rental properties or fixing and flipping houses, aren't right for everyone. If you want to put your money to work in real estate, but active investments don't sound appealing, there are several ways you can invest without taking an active role.
What passive investing is (and what it isn’t)
First off, let's clear up what the word "passive" means when it comes to investing. Despite the common misconception, passive investing doesn't mean that you don't have to do anything. It’s not as simple as choosing an investment, putting your money in, and never thinking about it.
Passive investing simply means that you aren't playing an active role in the business you're investing in. Stock investing is an example of passive investing -- when you buy shares of a company, you don't assume an active role in the company's day-to-day operations.
Instead, you simply have the ability to benefit financially if the company does well. Investing in a friend's business that you don't help run is another example of a passive investment.
However, it's important to remember that when you invest passively, you still need to do your homework before and after putting your money in. Let's look at stocks as an example. There's a time commitment that comes with properly evaluating a stock. Plus the ongoing need to keep up with how the company is doing, such as by reading quarterly reports.
3 ways to passively invest in real estate
Real estate can create great wealth, but actively owning and managing properties isn't right for everyone. There are three main ways to passively invest in real estate:
- through the stock market,
- through real estate crowdfunding, and
- by partnering with an active investor to own properties.
Let's look at each one individually.
Buy shares of a REIT
The best way to invest in real estate assets through the stock market is to buy into a real estate investment trust or REIT. Think of REITs like mutual funds -- investors buy shares in a REIT and the REIT's managers invest the capital in a portfolio of commercial properties.
Head over to our REIT homepage to learn all about this type of company. A key point to know is that REITs must distribute at least 90% of their taxable income to shareholders. This makes them excellent choices for income-seeking investors as well as those who want long-term capital appreciation. And since they trade like any other stocks, REITs are an excellent fit for retirement accounts like IRAs.
There are REITs that specialize in pretty much any type of commercial real estate you can think of. Certain REITs invest in apartment buildings, offices, data centers, hospitals, and more. These can be a great way to get exposure to property types that most individual investors couldn't afford to invest indirectly.
Invest in real estate crowdfunding
Real estate crowdfunding has dramatically increased in popularity in recent years.
In a nutshell, here's how it works: An experienced real estate investor or developer identifies an attractive investment opportunity. Let's say there's a run-down office building that would do far better if it were renovated and converted into a hotel. The developer (also known as the deal sponsor) negotiates the property's purchase, deals with lenders, and arranges for all necessary work.
However, if the developer doesn't have the necessary capital to complete the project, he or she may raise the rest from individual investors in exchange for financial interests in the project. This is known as crowdfunding.
Of course, this is a simplified explanation and there's a lot more to it. Head over to our crowdfunded real estate guide to find out more.
There are some pretty compelling reasons to invest in a crowdfunded real estate opportunity. Because of its single-asset nature and the typical inclusion of a value-adding strategy, there's serious money to be made when things go well. It's not uncommon for crowdfunded real estate investments to generate annualized returns of 15% or more for investors.
Be an active investor’s partner
Investing in rental properties can be an excellent way to build wealth -- but it can also be rather time-consuming. Even if you hire a property manager, owning a rental property still requires that you play an active role when it comes to maintenance decisions, not to mention the time spent researching, viewing, analyzing, and buying prospective rental properties.
However, there's an alternative. You could partner with someone who wants to invest and play an inactive role. This can be a win-win situation, as it allows you to put your money to work in residential properties without having to do all of the work, and the active investor (also known as the managing partner) has extra capital to pursue properties with.
In fact, some of my own property investments are partnerships. For example, I've invested alongside two other investors in an LLC, but the other two don't play active roles. I just give them a proportional share of the income the properties generate and they're entitled to a share of any profits made from a sale.
Is passive real estate investing right for you?
The main drawback to investing passively is that you have a lower return potential than if you were an active investor. In passive investments, you're generally paying whoever is playing an active role.
For example, when you're a silent partner in an investment property, the managing partner generally gets some sort of compensation for the time they put in. In a crowdfunded real estate deal, the project's sponsors get a cut of the profits. And when you invest in a REIT, there's an entire management team that's getting paid to invest on your behalf.
Even so, it can be worth sacrificing some return potential in exchange for sitting back and relaxing while someone else puts your money to work. This is especially true when the people who play the active roles have the know-how to make the investment a success.
Passive real estate investing can be a great way to create wealth over the long run without the hassles of actually having to be someone's landlord or manage a construction project. For many investors, it's the best way to go.