What is passive real estate investing and how does it work?

You don’t need to be a mogul to build wealth through real estate. With a clear plan, persistence, and a willingness to act, you can make it happen. It’s not instant or effortless. Every step requires thoughtful planning and follow-through. But the potential to build income that supports your lifestyle is real and within reach.

If you’re brand-new to the idea of passive real estate investing or want to broaden your horizons, here’s a look at what the average real estate investor should know to supplement or replace their income with a passive real estate portfolio.

What is passive investing?

Passive investing in real estate refers to earning an income from property ownership with minimal long-term effort. Most passive real estate investors look to generate a monthly income from renters, whether they’re individuals renting a home or businesses renting a workspace.

For example, an investor may buy a duplex and hire a property manager to find tenants and handle maintenance, repairs, and rent collection. If all goes well, the property owner should receive a monthly deposit in their business bank account for the rent, minus property management fees.

In addition to direct real estate ownership, passive real estate investors can join a small group of additional investors, invest in a real estate investment trust, or deposit funds into a crowdfunding platform, which offers investors a share of the profits.

Each type of passive real estate investment comes with unique risks, challenges, and opportunities. Understanding your financial goals can help you focus your funds and efforts on the best investments for your unique needs.

Passive real estate investments vs. active real estate investments

Before diving further into passive real estate, it’s important to compare passive with active real estate investments.

Here are some highlights of both types of investment:

Passive real estate investments

• Up-front effort: Most work revolves around selecting the right properties, with a focus on minimizing long-term effort.
• Earn primarily from cash flow: Investors typically aim to generate a recurring monthly income, most often through renting out their properties.
• Typically buy and hold: Passive investors usually buy and hold their properties for many years, providing an income that extends well into the future.

Active real estate investments

• Frequent effort: Active investors buy and sell properties more often and tend to treat their real estate activities as a part-time or full-time job.
• Earn from cash flow and appreciation: Active investors seek to increase the value of properties quickly by enhancing the property’s income or value.
• Multiple potential strategies: Earn through fix and flip, filling empty units, raising rental income, and other strategies.

As you navigate your real estate investment journey, you can learn more about your strengths and the nuances of different types of real estate investments.

How to generate passive income through real estate: Investment types explained

Now you know the basics of what passive real estate investing means. Here’s a closer look at different opportunities, with a wide range of risk and investment requirements, for those wanting to know how to invest in real estate for passive income.

1. Crowdfunding

Real estate crowdfunding platforms enable investors to pool their funds for specific investment properties. Many crowdfunding platforms require participants to be accredited investors, which entails a specific minimum income or net worth. Minimum investments can range widely, varying from around $500 to $25,000 or more.

Crowdfunding comes with several significant benefits. While minimums apply, you can often buy into multiple projects for the same price as a single-family home, even after a mortgage, allowing more diversification. And investors are completely hands-off, making it a truly passive investment. However, you’re also giving up control over the investment to property managers, and those minimum investment requirements can be a big hurdle for some households.

2. Real estate investment trusts

A real estate investment trust, commonly referred to as a REIT, is a type of company or fund where investors purchase shares, and the REIT’s managers handle the rest. Many real estate investment trusts are easily bought and sold, like stocks, and many brokerages allow you to buy fractional shares starting with an investment of around $5, if the REIT is publicly traded.

REITs must have at least 100 investors, earn at least 75% of their income from real estate activities, and pay out at least 90% of profits to shareholders as dividends, among other rules. REITs are a good option thanks to low minimum investments and high liquidity. However, you have to trust that the company is well-managed and generates sufficient profits to offer healthy dividends.

3. Real estate funds

Real estate funds are a type of mutual fund or exchange-traded fund that directs investor funds into a range of real estate investments. For example, a real estate ETF could invest in a mix of REIT stocks or track a real estate investment index. Through those entities, you’ll likely own commercial property, multifamily homes, or entire developments. Each has its own focus areas, and some may operate like rental property mutual funds. Like publicly traded REITs, you can often buy in with as little as $5 through your brokerage account.

With real estate funds, you can choose funds with favorable performance histories and management fees. If you believe in the fund’s investment style and managers, you can invest passively, trusting that the managers will make profitable investments based on their knowledge and research. But you also have little control, and there may be less transparency than in other types of real estate investment.

4. Remote ownership

With remote ownership, you can invest in a property far from where you live while trusting a property manager to handle the day-to-day operations of your portfolio. For example, investors in high-cost areas like California or New York may opt to invest in lower-cost regions, where they can acquire more properties for their money.

An advantage of remote ownership is that you can pick and choose areas where you expect to earn the biggest return on your investment. But on the flip side, you’re far away if something goes wrong, which means you have to put even more trust in your property manager.

5. Fractional ownership

With fractional ownership, you join a small group of investors to buy one or more properties. Unlike large real estate investment funds, you get more fine-tuned control over where you’re investing and how the property is managed. Still, you can share the risk and rewards with your investment partners.

You can also tap into the knowledge of other investors in your group to learn more and improve your investment strategy. Depending on your location and the nature of your relationships with partners, you can manage your ownership interest in several ways. Common agreements include tenancy in common, where the property is shared by multiple owners. If you’re investing with a spouse or other family member, you might consider joint tenancy or tenancy by entirety.

The benefits and risks of investing in passive real estate

Passive investments can be a great way to make some extra cash and invest in your future, but like any investment, they’re not risk-free. It’s wise to consider the benefits and risks before starting.

Passive investing benefits

• Generate passive income: The most obvious benefit is earning passive income. Who wouldn’t want more cash flowing into their bank accounts?
• Less money required: You don’t need deep pockets to get started with passive real estate investing. While buying rental property on your own can be expensive, options like real estate crowdfunding platforms and REITs let you invest with much smaller amounts.
• No expertise necessary: You don’t have to be a landlord or know how to manage a multiunit property to invest. With passive investments like REITs or real estate funds, professionals handle the heavy lifting. You just provide the capital.
• Diversification: By investing in smaller amounts, you can afford a broader range of unique investments. With more diversification, you spread out your risk, which is valuable if one investment goes bad.
• More liquidity: Unlike owning a property outright, many passive real estate investments are easier to buy and sell. That means you may have access to your money sooner, depending on the type of investment.
• Potential tax benefits: Different types of passive real estate investments may offer unique tax benefits, such as allowing income to be taxed as a capital gain rather than ordinary taxable income.
• Less work: There’s usually no physical labor or work involved with passive real estate investing. You just invest your money and watch it grow. There’s no need to flip houses or manage rental properties.

Passive investing risks

• Not as profitable: Passive real estate investing can generate steady income, but it typically doesn’t offer the same income potential as flipping homes or managing properties directly.
• Hands-off approach: When someone else is managing the details, you miss the opportunity to add value through your efforts or make strategic adjustments to boost returns.
• Real estate market fluctuations: Even if you’re not involved in the day-to-day, your investment is still tied to the ups and downs of the real estate market and economy as a whole, which can impact income and property values.
• Property management issues: If the property manager fails to perform their duties, you may face delayed maintenance, unhappy tenants, or lower occupancy rates. It’s easy to find financial horror stories about investors who trusted the wrong property manager.
• Vacancies: An empty unit means no income. With passive investing, you’re still exposed to the risk of vacancies, even if you’re not the one trying to fill them. And when you’re not managing the property yourself, you may experience slower turnovers between tenants.
• Lack of control: You’re putting your trust in someone else to manage the investment well. That can be tough if you’re used to being hands-on with your money.

FAQ

Even experienced passive real estate investors can continue learning and enhance their real estate investment IQ. Here are our answers to some common questions about passive real estate investing.

How does passive real estate work?

In passive real estate, investors put funds in properties individually or in conjunction with other investors to generate income without requiring ongoing work. You can start by setting clear goals and saving up. Researching the best type of passive investment for your finances is also important. Starting small can help you learn the ropes while limiting your risk.

Is real estate investing a good source of passive income?

Real estate can be an excellent source of passive income, but it’s not guaranteed. Directly owning properties can sometimes be more work than expected, and other forms of passive real estate income may not perform as well as expected. Spending time to analyze each investment before making a purchase can help you identify the most profitable opportunities.

Is real estate worth investing in?

Real estate investing is well worthwhile for many individuals and households. If you understand the risks and potential benefits and can afford to get started, real estate investing can be a lucrative way to grow your income and wealth.

What are the tax advantages of passive real estate investing?

When investing in real estate, you may encounter several tax benefits. These include opportunities to offset your income through depreciation, deducting related expenses, and rolling over capital gains into new properties using a 1031 exchange. When in doubt, working with an experienced tax expert can be helpful.

What are additional passive income ideas?

Passive income goes far beyond real estate. Traditional stock, bond, mutual fund, and ETF investments can generate passive income, but each comes with unique risks, benefits, and tax implications. For most investors, a mix of real estate and other assets is the best choice.

The bottom line: Passive investing has its upsides and downsides

Passive real estate offers an exciting path to growing your income and wealth, and you have many routes into the industry. Whether you’re looking to pool your money with other investors or buy properties on your own, passive real estate investing can lead to outstanding results. But it’s not without risks and other potential drawbacks.

Before investing, most investors should consider the type of investment, property type, location, market conditions, and how the investment strategy aligns with their financial goals. If you’ve done the due diligence and understand what you’re getting into, passive real estate investing could be a perfect fit for your finances.

If you’re ready to buy a residential investment property or make an investment in your own home, start an online application today to find out how Rocket Mortgage^® can help.