Passive Real Estate Income Opportunities

When people think of real estate investment, direct investment (physically buying the property) might come to mind. However, other types of real estate investments don't require owning property. Here are ways to invest in real estate to earn passive income without having the headaches of owning, maintaining, and managing the properties.

Explaining Passive Investments

A passive investment is when you pay other experts to buy and manage real estate and hopefully reap the benefits of owning your share. Besides putting in some money and monitoring the performance of your investment, that is all you have to do. Others buy, manage, and sell the property. You just sit back and collect your share of the operating profits and appreciation if the project is sold.

Here is how passive investment compares to active or direct investment

Passive Investment

• Set-Up: Easier – Conduct due diligence
• Time Commitment: Minimal – Performance review
• Liquidity: Usually liquid (except private REITs)
• Diversification: Allocate investment funds easily
• Risk: Depends on the manager's skill
• Investment Returns: Returns reduced by fees
• Supervision: Live anywhere

Active Investment

• Set-Up: Challenging to acquire a property
• Time Commitment: Significant – Manage investment
• Liquidity: Illiquid – Need to sell the property
• Diversification: Low – Concentration of capital
• Risk: Risk determined by your skillset
• Investment Returns: Determined by market conditions
• Supervision: Live closely or visit investments frequently

Types of Passive Real Estate Investments

There are many types of passive real estate investments in use. They include real estate investment trusts (REITs), crowdfunding, Delaware Statutory Trusts (DSTs), and real estate mutual funds.

Real Estate Investment Trusts

A real estate investment trust (REIT) is a legal structure that pools investors' funds to finance large income-producing projects, such as apartment buildings, hotels, commercial buildings, offices, and medical facilities. The REIT is required, by law, to distribute at least 90% of its taxable income to its investors as dividends each year. As a REIT investor, you could also benefit from appreciation of the value of the underlying assets.

REITS may be private or public companies. Private REITs aren't available to the general public, have a higher minimum investment requirement, may be restricted to investment by only "accredited" investors, and aren't regulated by the SEC. Public REITs are available on the public stock exchanges and must follow SEC regulations.

Pros and cons of REIT investments

The benefits of REIT investments include:

• Minimum investment – Many Public REIT shares sell for less than $50, some for as low as $10 per share. The minimum investment in a Private REIT is higher, and it might require an investment of $10,000 or $25,000 or more.
• Regular dividends – REITs are required, by law, to distribute at least 90% of taxable income annually to investors in the form of dividends.
• Diversity – REITs may be highly specialized and have a portfolio focused on certain types of properties or real estate with specific characteristics, such as retail space, office buildings, restaurants, etc. REIT can also focus on geographic areas.
• Professional management – The REIT team buys, sells, and oversees real estate operations. You aren't responsible for hands-on management.
• Liquidity – Publicly traded REITs are highly liquid. You can sell your ownership interest in a public REIT just like any publicly traded stock.  

However, REIT investments have the following downsides:

• Taxes – Dividends from a REIT are taxed as ordinary income in the year earned. This might require a tax-advantaged strategy to defer taxes.
• Price volatility – Share prices of publicly traded REITs can be influenced by economic conditions and the stock markets' ups and downs.
• High fees – Privately traded REITs have higher minimum investments and could have extra fee requirements. 
• Lack of Liquidity - Private REITS lack liquidity, making them difficult to sell as there is no public market for the ownership interests.
• Potental value loss - Investment in any Public or Private REITs may lose value. Your selling price may be lower than the price you paid.
• Loss of control – When you invest in REITs, you don't have the daily management headaches of direct investments. However, you also don't have control over management decisions, including capital expenses, dispositions, or acquisitions.

Crowdfunding

Crowdfunding occurs when investors pool money to fund real estate projects or properties and share in the returns. There is a General Partner who manages the project for the investors who own a portion of the deal as a passive investment. 

Search on the internet and social media for "real estate crowdfunding," and you will find plenty of projects and platforms to consider.

Pros and Cons of Crowdfunding 

In addition to offloading property management tasks, real estate crowdfunding benefits include:

• Low minimum investment – Some platforms require only $100 for you to participate.
• Project diversity – Crowdfunding has been used to fund commercial property development, mixed-use, renovations, and conversions (from apartments to condos),
• Returns – Potential high returns for minimum investment.

The crowdfunding downsides include:

• Transparency risks – Investors may lose their money if a real estate project fails or the platform goes under.
• High fees — Crowdfunding platforms charge a fee that may be substantial (up to 10% of the funding amount raised). 
• Platform Risk - There is the potential of a poorly managed crowdfunding platform that does not conduct proper due diligence (collateral, developer expertise, creditworthiness, etc.), which would normally be needed to support traditional real estate financing.

Delaware Statutory Trusts

With Delaware Statutory Trusts (DSTs), investors purchase beneficial interests in a trust registered in Delaware. The trust owns and manages the property or properties. Meanwhile, investors purchase fractional shares in the trust. Neither the projects nor the investors need to be in Delaware to create or be involved with a trust.

Pros and Cons of DST Investments

DST investments can provide the following benefits:

• IRS 1031 exchange eligibility – A DST can qualify as a "like-kind" property for a 1031 exchange. When handled correctly, this means that you can potentially defer capital gains taxes upon the underlying property's sale by reinvesting the proceeds into another DST or real estate property of greater or equal value.
• Limited liabilities – Investors are not personally liable for the trust's debts or obligations.
• Co-ownership – Allows individual investors to co-own high-value properties that might be unattainable individually.
• Wealth preservation – DSTs can be part of estate planning, allowing heirs to inherit real estate interests with potential step-up in basis benefits.

However, DSTs come with the following downsides:

• Illiquidity– There are few secondary markets where you can sell your DST shares. This means you're tied to the investment until the trust sells the property.
• High investment minimums – Getting into a DST can be costly; the average is $100,000. Additional fees can be assessed either upfront or when the property is sold. 
• Market Risk – Property values and rental income may fluctuate with market conditions, which could impact your returns.
• Investor requirements – An investor must be accredited to invest in DSTs. An accredited investor has over $1 million in net worth (not counting a private residence) or has made at least $200,000 annual income for the past two years ($300,000 for a married couple filing together).

Real Estate Mutual Funds

Real estate funds are a subcategory of mutual funds. These can be open- or closed-end funds managed by professional fund managers. Open-end funds continue to accept investments until dissolved. Closed-end funds stop taking investments when they reach their predetermined end, which could be a date or a total funding amount. 

Unlike stocks or REITS, when you invest in a mutual fund, you buy shares directly from the fund itself. When you sell the mutual fund shares, you sell them back to the fund. Mutual funds trade only once a day, after the stock market closes.  

These funds may have many kinds of real estate assets in their portfolio, including REITs, real estate operating companies (REOCs), securities or bonds associated with real estate markets, and perhaps direct ownership of real estate properties.

Pros and Cons of Real Estate Mutual Fund Investments

The advantages of investing in a real estate fund can include:

• Diversification – Funds invest in many kinds of real estate assets, meaning the risk is spread across the portfolio.
• Potential dividend income – Some funds distribute income through regular dividend payments.
• Professional management – A qualified management team takes care of buying, selling and managing the assets. The team might also include researchers who examine asset performance and trends. This can lead to building well-performing portfolios.

The cons of investing in real estate mutual funds are:

• High fees – A mutual fund's fees, known as "loads," can be assessed when you buy into the fund or when you leave it. Either way, this could mean less return for you. 
• Loss of control – As the fund's manager makes investment decisions, you have no control over when properties are bought or sold. 
• Stock market volatility – Real estate mutual funds are tied to the stock market. This means their value can fluctuate even if underlying real estate markets remain stable.

Passive Investments and Due Diligence

Passive investments can provide simplicity and diversification. The benefit lies in their ability to create income without constant management while providing steady, predictable returns. Passive investments can also be helpful for long-term wealth building.

However, passive income instruments require the same amount of research as any direct property investments. Before making any passive real estate investment, it is wise to conduct due diligence to determine whether the investment is attractive, whether any projections are realistic, and whether the proposed properties have sufficient value. Also, research the passive investment vehicle, whether it is a crowdfunding platform, real estate fund, REIT, or DST. Essential factors include the project manager's track record, years in business, and average rates of return.

When analyzing properties for direct or passive investments, you can rely on PropertyReach for comparable research and in-depth data. For more information, visit the PropertyReach website and sign up for a seven-day free trial.