Are you an active real estate investor or a passive real estate investor?

Did you know that just because you are seeking passive investment income does not mean that your taking on a passive investor role.

What investments truly are passive and generate truly passive income, and what investments are you potentially pursuing that are ACTUALLY active in nature and whose passive income may not be that passive?

What is active investing, and why should investors know the difference? Active real estate investing involves directly participating in the buying, selling, and management of real estate properties. Unlike passive investing where you might invest in a REIT (Real Estate Investment Trust), active investors are hands-on, taking responsibility for the entire process.

• Hands-on approach: You're actively involved in research, analysis, property selection, negotiations, and potentially even property management.

• Time commitment: This can be a full-time job, requiring significant time and effort to be successful.

• High level of involvement: You're responsible for everything from finding the right property to managing tenants and repairs.

Some common examples of active real estate investing include:

• Fix-and-flips: Buying a property below market value, renovating it, and then selling it for a profit.

• New Construction: This involves buying an infill lot or raw land and developing it for development purposes.

• Rental properties: Purchasing a property to generate income through tenant rent payments. This can include residential, commercial, multi-family, and even mixed-use assets.

• Wholesaling: Assigning contracts on properties to other investors for a fee.

Active real estate investing offers the potential for high returns, but it also comes with greater risks and requires considerable time and effort. The investor assumes the responsibility and liability of owning the real estate.

Different roles of active investing can vary and can be convoluted at times. Often, passive investors believe they will be passive because the investment generates “passive income” (i.e., owning rentals). Yet, they can quickly find themselves playing an active role, which defeats the passive desires they wish for. The most overlooked issue of passive investors investing in “passive investments” is which side of the capital stack the investor is investing on. I have written extensively on the Capital Stack, yet it bears repeating here. When investing in real estate, you can only be on one of two sides: Debt or Equity. ALL equity investments are active in their roles. Equity investments also convey the two main ingredients of Active Investing, and that’s assuming the liability and responsibility of those assets.

Active investing roles are most commonly seen as this:

• Owner: If the investor personally owns the asset or owns/ controls an entity that owns the asset, they and all parties involved in the ownership of the asset are considered active, even if they believe they are investing passively.

  • Managing Member - The owner and decision maker of an LLC

  • CEO/ President - The officer of a corporation

  • GP/ Sponsor - The General Partner, or Sponsor, is the person/ entity that owns the assets through a syndication. Syndication is a vehicle by which many investors use to raise funds to purchase a commercial or multifamily asset

  • Trustee - The legal representative of a trust, which can own an asset.

• LP Investors: This is where the waters can get murky. LPs or limited partners usually have a passive investment role within a syndication. However, LP’s are playing on the side of the active investor, primarily because their funding will be used for the downpayment, renovation, or construction of an asset, and even holding and operational costs. When an LP invests in a syndication, they may legally be considered a passive investor, however their capital is being used on the euity side of the real estate capital stack. Therefore, whether they realize it or not, LP investors are exposed to the same risks as active investors without any control or decision-making ability over the project or plans of their investment.

You may be thinking, “Well, Edwin, if an LP is really an active investor, and I’ve always thought that LPs are passive investors, what is a truly passive investor?” This is the question, right? A passive investor is traditionally defined as someone who invests in real estate without the hassle of being a landlord or directly managing properties. It allows you to benefit from the potential gains of the real estate market without the hands-on work.

• Passive: You don't deal with day-to-day management or decision-making about the properties. Most importantly, you are not on the equity side of the capital stack.

• Real Estate Investment: Your money is still tied to the real estate market, aiming to grow through rental income or property value appreciation.

There are several commonly understood ways to achieve “passive” real estate investing, such as:

• REITs (Real Estate Investment Trusts) & Syndications: These companies own and operate income-producing real estate. You invest by buying shares of a REIT, similar to buying stocks. While this may, on the surface, look passive, in reality, you should conduct your due diligence to know if the REIT is using leverage, i.e., debt, to purchase these assets. If the REIT is using a combination of equity and debt to acquire assets, then it is likely passive investors' capital is on the equity side and, therefore, open to the ramifications of assuming the liability and responsibility of the asset.

• Real Estate Crowdfunding: Platforms allow you to pool your money with other investors to finance real estate projects. Now, we are getting closer to TRULY investing passively while earning passive income. The key word here is you are “financing” real estate projects. This means the passive investor is investing in opportunities like a bank, becoming the lender. This is investing in the debt side of the capital stack.

• Real Estate Notes: In my opinion, THIS is where truly passive investing shines forth. When passive investors invest in the loans secured to real estate assets, they are now playing on the correct side of the capital stack, which is passive and generates truly passive income.

Passive real estate investing offers advantages like:

• Lower barrier to entry: Requires less capital than buying a whole property yourself.

• Less time commitment: You don't have to manage the 3x T’s of real estate: Tenants, Termites, and Toilets.

• Diversification: Spread your investment across multiple properties.

What are Passive Investments that Generate Passive Income?

Now, we are getting to the real nitty gritty and addressing the hard questions. “If common passive investing vehicles (REITs and Syndications) allow investors to be “passive” in the day-to-day operations of an investment, yet expose them to the risks of active investing, then what investments truly are passive and where do I find them?”

I’m glad you asked. If you notice the above definition of a passive investor, you will see that investing in debt or loans is the only true way to invest passively while truly generating passive income. Let's examine why this is the case and why I firmly believe that passive investors should consider and identify these assets to invest in. Then, I’ll let you know where you can go to seek out these types of investments.

• Liability: As a passive investor, you DO NOT want to assume the liability of an investment. Assuming the liability of an investment means that the risks of owning that asset now fall on your shoulders. This liability can quickly turn a great investment sour should the investment not perform as expected. Liability can easily be determined by who has to obtain insurance on the asset. As an Active Investor, this is made evident; the asset owner assumes these liabilities. If you are a “passive” investor in syndication or a REIT, guess what? You are still investing on the active side of the capital stack (i.e., Equity), and therefore, you are also assuming the liability of that asset. Shocker right? However, when investing in Debt, say you invested in the loan that is secured to the asset, as the lender, do you have to pay for the insurance on that property? No. If the owner does not maintain proper insurance, can you, as the lender, move that loan into default and take the property back if the owner does not remedy the issue of improper insurance? Yes. Easy and simple. Passive investing in debt = more control without the liability.

• Responsibility: Asset owners are responsible for the property. Improving the property. Coordinating contractors and managing tenants. Making business decisions concerning the asset and the plans of that asset. This can all be easily seen and realized on the active investing side, i.e. Equity. Again, as a passive investor in a REIT or syndication, you do not have any say in these issues (hence, why it's called “passive”), yet your capital is at the same risk as the active investor. In many cases, YOUR capital is the ONLY capital at risk. If you decide to invest as an LP into a syndication or REIT, ensure you are comfortable with how little the active investor is putting into the project. If you are 100% OK with the GP or Sponsor not risking any of their capital yet risking all of your capital, then you should be aware of the risks you are assuming in the investment. When a passive investor invests in debt or the loan secured to the underlying real estate, the responsibility of the asset ownership is NOT on your shoulders; it's on the active investor and their LPs. When you get a loan from a bank to buy a property, does the bank pay for the annual maintenance of the major components of the asset, i.e., roof, HVAC, plumbing, and electrical? If you bought a rental and got a loan from the bank, does the bank pay for property management, tenant evictions, tenant screenings, and tenant maintenance calls? Does the bank pay for the improvement of the property? Well, in some cases, yes, but it's only if the numbers make sense to the bank, and ultimately, you must improve the property first and then get reimbursed by the bank. It's still your responsibility, but you may use the bank money to do this. Guess what? When you invest in debt, you are playing the bank's role. You are able to shift the responsibility of asset ownership to your borrower, and the borrower must adhere to and meet all of your requirements laid out in black and white in your mortgage, or you can take the asset back.

• Cashflow: Yes, active investing and even passive investing as an LP, will yield “cashflow” but there is a catch. Should any of the tenants in your investment NOT pay, the active investor and their LP’s MUST still pay the bank. By law and the mortgage documents, they are obligated to adhere to all the terms expressed in the security instrument: the mortgage or the deed of trust. I’m sure you're seeing a theme; guess what? When you invest in debt and take on the bank's role, the active investor and all their LPs on the active side of investing must pay you as the lender, regardless of whether the tenants make their payment or not! No other investment offers the security and dependability of being the lender.

Where can you find these types of passive investments? You can research online for debt funds, as well as crowdfunding sites to invest in loans. You can also visit your local real estate clubs and network with active investors and builders to finance their projects. However, in most cases, you must have all the money the borrower requests to make the loan. Does the investor need $1M to build a new SFR house? Well, you need $1M in cash to be able to make the loan. If you invest through a crowdfunding platform, you may be able to invest in a slice of a loan, but you cannot research and conduct your due diligence on that loan. You have to invest “blindly” into these crowdfunding loans, trusting that the crowdfund manager properly underwrote each loan and mitigated the risks appropriately. PeerStreet was a great example of how this went completely wrong.

I manage, Blue Bay Fund I, a customizable debt and equity fund, and we provide accredited investors the true ability to diversify and fractionally invest in loans and syndications that we have already made. If you are looking for a way to invest passively and earn truly passive income, being confident that your investment is as passive as it can be, I would encourage you to check out my fund presentation below. It’s completely free and holds no obligation to invest. After you watch the presentation, you may reach out to me, and I can answer any of your questions as to why passive investing by, with, and through Blue Bay Fund I will be a recession-proofing strategy for you and your families generational wealth.

Where are you on the Active versus Passive scale?

Below, my team and I have provided investors with a one-page diagram that quickly and efficiently details and explains whether you are choosing to be an active or passive investor and where you should focus depending on three key metrics: Experience, Wealth, and available Time. This download is free and can help guide you as to what type of investments you should be pursuing, depending on whether you are a passive investor or an active investor.