Active Vs. Passive Investing
When you are investing in real estate, you can either be a passive investor or an active investor. In general terms, a passive investor is someone who provides the money but has no involvement in the day to day decisions or activities whereas an active investor provides the money and also has involvement in the decisions and activities. An active investment generates revenue from the work you have done and the money you invested, whereas a passive investment generates revenue only from the money you invested.
Note that if you meet the IRS definition of a real estate professional, all of your real estate investments are considered to be active. Real estate professionals include persons that spend 750 hours per year working in the real estate industry, paid employees who own 5 percent or more of a real estate business, full time commission only real estate agents, and full time developers of their own real estate.
Examples of Each
Fix and flip is definitely an active investment. Owning and managing your own property is definitely an active investment. When you are the landlord of a property you own, then that is an active investment. On the other hand, syndications and REITS (real estate investment trusts) are passive investments. If you are an investor and your only involvement in the property after purchase is when you receive your distribution, then that is a passive investment.
An investment can change from being active to passive and vice versa. If you purchase a property and are self-managing it, then it is an active investment. If you then hire a property management company, then you now have a passive investment.
In reality, defining a real estate investment as active or passive isn’t always so black and white. It’s more of a range. For example, if you are part of a group of investors in a property but you are also the person in charge of managing that property, then you both an active and a passive investor. Regardless, you’ll end up more on one end or the other (active vs. passive), based on how much you are involved in the management of the property after the purchase.
Which is Better?
There is no cut and dry answer to this question. It largely depends on a variety of factors, including how much time you have to devote to the investment, how much money you have to invest, and more.
Active investments require more time, and since you are managing the property they require more experience as well. This also means they can be more of a hassle and a risk. Managing the property means you have more control, though, and it also means you get better tax benefits. Since it is your own property, you can decide when to sell, which means you also control the liquidity of your investment.
Passive investments have the least hassle and require less experience, but you also have less control and less tax benefits. However, if you don’t have a lot of time to devote to the investment (including finding the correct property to purchase, managing the property, and determining when and how to sell), this is the better option for you.
Conclusion
In the end, you need to evaluate what you are looking to get out of the investment and how much time you have to devote to it. That will determine whether you should be an active investor or a passive investor in real estate.