By Dr. Peter Kim of Passive Income MD, WCI Network Partner
When I talk to people about the benefits of investing in real estate , I often hear this response, “I would, but I don't want to be a landlord.”
While I believe that actively investing in real estate by owning rental properties is a proven path to creating wealth and cash flow, it is certainly not the only way to get the benefits of real estate investing. And honestly, being a landlord is not for everyone.
In fact, as I've gotten busier with my various ventures and activities with my family, I've found myself leaning more and more toward passive real estate investing. At this point in my life, it seems to provide the best return of capital for the time spent of any investment I've made.
So why don't more people invest in passive real estate opportunities?
- They don't know the different options available to them.
- They don't know how to do the proper due diligence.
Well, this post will help you with reason #1.
Here are five ways to invest in real estate without being a landlord.
#1 Invest in REITs
Real Estate Investment Trusts (REITs) are companies that hold real estate and allow their investors to buy and sell their shares so that the trust could pay dividends and earn value on the properties in the long term.
REITs can either be publicly or privately traded, and the trade is conducted in the form of equity, not debt. Most of these companies have multiple favorable cash-flow generating properties that are worth millions or billions in value.
So as an investor, you don't own the properties directly; you own a share of the company that owns and operates the properties.
For investors looking to start building a portfolio, going with the REITs is an easy way to get started. You can simply do it through your current trading platform. It is also quite liquid as you can simply move in and out of the investment with a simple click of a button.
However, there are some downsides as you might miss out on many of the direct tax benefits of investing in real estate, like depreciation.
#2 Real Estate Syndications
This is yet another effective way of investing in real estate without buying a property. In a syndication, investors pool their financial resources to invest in big projects which they couldn't have purchased or managed on their own.
For example, a sponsor might present a deal where they're purchasing a 350 unit apartment building and is looking to raise $15 million from investors to complete the deal.
As an investor, you invest with a sponsor who puts the deal together and runs the deal. You're expected to do your due diligence before investing, and once you're in a deal, expect to be on the ride the entire time.
Depending on the specifics of the deal, they can run from 3-7 years. As an investor, your only expectation after making the investment is to check for deposits into your bank account and file taxes on it each year.
#3 Invest in Real Estate Funds
Syndications are often thought of as single properties or deals. A real estate fund, however, will take their capital and invest in multiple properties, all under the umbrella of the fund.
As an investor, you invest your capital, and the fund operators will go out and purchase multiple deals.
The benefit to you as the investor is that a single investment results in diversification across multiple properties and locations. The downside is that the fees are often a bit higher, but that's the tradeoff for diversification.
#4 Note Investing
Notes in simple terms can be referred to as a promise to pay. For instance, a personal check in your name is a note. When a property is sold, the document promissory note defines the terms of the loan.
Although not secured by collateral, the note is considered to be the safest way of investing in real estate. In this investing, the investor purchases the secured debt and becomes the lender. Investors buy notes on discount and then move them along to lenders.
You can invest in notes in different ways:
- Performing Note Investing – buy to hold and buy long sell short.
- Non-performing first-lien investing, and non-performing 2nd Lien Investing.
Each of these types is unique in their way and offer potential for investors who are starting in real estate.
#5 Debt/Hard Money Loans
Hard money loans are also known as a bridge loan, and they are used for short-term lending. Real estate investors that are looking to finance a project use these loans to get things started. Most house flippers use this tool to renovate or develop a property so that they can earn a profit. Private lenders often issue these loans.
Other than offering convenience, these loans offer flexible terms since they are being handed out by a private lender. Similarly, when it comes to collateral, it is up to the lender to decide whether they want to give you a leeway or not.
If you want to become an investor, you need to pose yourself as a lender and give out money to borrowers on your terms. You can either ask for a share or a fixed percentage according to your needs.
Make It Worthwhile
Real estate investing is much more than buying and selling properties. It is an entire industry which offers up a ton of ways to get involved according to your goals and willingness to commit time and effort. It is up to you to decide which path you want to go.
The key is to understand how to do the proper due diligence with these deals up front. Since you're relying on others, it makes sense to understand who you're investing with and what you can expect from a return standpoint.
Different ways to learn how to do the proper due diligence include educating yourself through books, courses, and conferences. And there's always learning by experience.
If you'd like to learn how to do the proper due diligence in a short period of time, feel free to check out our course and community, Passive Real Estate Academy.
How have you successfully invested in real estate without being a landlord? Comment below!
Peter,
I have participated in #’s 1, 2, and 3. So far, I have had the best returns with #3. I have found a couple groups that have consistently turned out good returns. What funds have you used that have provided consistent returns?
Thank you,
The risk of someone taking a lot of people’s money and just disappeared doesn’t sit well for a hard real property mindset. I would rather put money in high yield dividend stocks or REIT’s to divest.
Real estate should be something you can see, smell, and touch; thus the term “real”. RE does not necessarily need landlord based, it could also be of agricultural such as timberland or ag land that can be harvested or cultivated without a single human tenant.
Checkout Sch F as opposed to Sch E for passive income.
Jim, Peter,
Thanks for the posts. I have to admit that the real estate investing invokes some FOMO in me and I am sure a fair bit of your readers. I have made good equity on my first and only house purchase (bought a relatively modest house for my income which will be paid off in a handful of years). I am in a higher paying specialty and don’t really have the time/insider knowledge/bandwidth/desire for direct real estate ownership.
Frankly I was very close to putting in a substantial investment with one of your sponsors. I liked them and their returns looked fantastic….actually a little too good. I almost felt myself wanting to put in more than I originally had planned because the returns seemed that good. My wife is more fiscally conservative and ultimately she didn’t want a non-trivial sum of money with just one company.
This company had all the reassuring things….outside audits, etc but she wasn’t convinced that we couldn’t just lose all our money.
Ultimately we didn’t invest. I will probably have FOMO about it. But this blog also preaches to not take uncompensated risk….I would love to hear a strong argument I could bring back to my spouse about how it isn’t crazy to consider a private real estate fund.
Thanks to both of you for contributions to this communities’ financial success.
You should listen to your wife. It is far more important that you guys are in agreement with each other about your investing plan than what exactly the plan is. My wife wouldn’t let me invest in a life settlement fund a few years ago. That’s okay, there are plenty of other great investments. It turned out the fund I was looking at ran into legal problems, so she saved us from that bullet.
You absolutely can lose all your money in real estate due to manager risk/fraud and/or leverage.
It would be nice if Peter Kim would comment on the eviction moratorium.
Peter (at) passiveincomemd.com is probably the easiest way to reach him with questions. Doubt he monitors these comments too closely on these republished posts.
Napoleon,
I’m trying to make it on lousy Soc Sec of
less than 1500 a month. Are there any investment platforms that allow “fractional investments?” That’s be for smaller investments of say 100’s vs 1,000’s. And if they do, which way(s) would you invest for returns that exceed the Real inflation rate, which is Usually at least 3 times what the d govt says? On the sale of RE whether actual physical property or thru stock REITS etc one has to hold on for at least 366 days to avoid a bigger hit tax wise? Can you tell I’m a Total RE newbie? I wonder too how one makes smart buys re agricultural/forest/raw land and where’s best? The drought out West is worsening by the day and affecting people negatively.
Not really. You usually need to be (and probably should be) an accredited investor ($1M+ in investable assets) to invest in these private deals. If you’re living on less than $1500 a month how are you going to carve out money to invest?
If you want returns that are 3 times what the CPI-U says inflation is, you’re going to need to take substantial risk and hope for the best. Right now inflation is 5%, so you’re talking 15%+. Good luck.
Yes, short term capital gains become long term capital gains after 1 year.
David,
I believe you are a ringer for reading this while taking in SS 🙂 Primary home can be sold tax free after 2 out of 5 years from appreciation out of basis. If your primary income is SS in this case, then your long term capital gain(selling after 365 days) is 0% . And you may not even need to file IRS tax for the such 1099-SS income(not sure which state you live).
I invest consistently in two areas: RE (rental homes and raw land) and high yield dividend stock and REIT. One can obtain timberland cheaply with nearly no property tax due to designated forestland tax exemption. And one can even live semi-offgrid in there with least expense in this case. Timberland in the west is not affected as much due to winter snow as primary source of water. Ag land requires water right to irrigate and does take more work to grow something. However trees just need good maintenance through dead wood removal and thinning by selling wood. Raw land can be seen as inflation proof and is a long term investment with very good multi-purpose use.
On stock and REIT dividend returns, you could find quite a few that can beat inflation, if not itself, then at least twice(with use of DRIP). Putting all cash in the bank is probably the worst thing one can do because $100 today will worth only $90 or less in just a few years.
I do not trust a second hand private funds with any promised return. Do things that only I can control, that is tangible, and with tolerable risk.
Does option #3 (private real estate fund) also miss out on the tax benefit of depreciation listed under #1 for REITs as well?
Great question when it comes to an equity fund. I have been told that despite adopting a REIT structure (as many have done recently in order to qualify for 199A tax benefits), an equity fund can still pass through depreciation to its owners. However, I have not yet received a K-1 from an equity fund that has adopted a REIT structure in order to verify that and everything I read says that it cannot pass through depreciation as depreciation. Certainly most REITs do not do that as they don’t send out a K-1, just a 1099.
However, a significant part of REIT distributions are technically returns of capital, and in some ways, since REITS do get depreciation on their properties, this is the way they pass that depreciation on to investors, in that not all of an investor’s distribution is taxable. Realty Mogul gives a good explanation of this here:
https://www.realtymogul.com/knowledge-center/article/depreciation-taxes-reit-and-private-placement-investments
For a debt fund, might as well have it be a REIT. At least that helps a little with the taxes.
Hi Jim,
Do you have a blog post on which real estate investments you have specifically chosen for yourself and why? ie why one DLP fund versus the other…why specific Origin fund over another
I do write what I have actually invested in regularly. I have written more specifics in the past but now do much less due to two issues:
# 1 Most LLC agreements do not allow you to do anything that would harm the partnership. When I have written negative things about a real estate deal (such as a syndication where fraud was involved and investors may face a total loss), they’re quick to point that out. They’re fine with me saying good things, but bad things have legal consequences for me. I figured it was more honest for my readers to just leave things more vague rather than specific if all I could say was good things when I got specific.
# 2 If I were to recommend DLP over Origin then all my readers would invest in DLP and none of them would invest in Origin. And then Origin would stop advertising with me. Or vice versa. We’re running a business here and conflicts of interest abound. Plus, how would I then look when Origin outperformed DLP (or vice versa). I’d lose trust and credibility. Since I don’t actually have any idea which one will provide the best risk-adjusted returns in the future, I’ve decided to just introduce people to these firms, let them know what I’m doing, and then as accredited investors they can make their own decisions. Yes, there are different things I like about each fund and I try to mention those, but I use both to provide diversification against manager risk.
My choice of one fund over another is often due to availability at the time I need to invest rather than preference. That’s less an issue with evergreen funds like the DLP funds or the Origin IncomePlus fund, but there are plenty of funds that were only open to invest when I didn’t have any money to invest in it or my AA didn’t call for more real estate. Plus, how many funds does one investor really want to manage? I think I’ve got 15 or more different real estate investments right now. Adding another one (with its record-keeping and tax-paying duties) isn’t super appealing even if it looks awesome. But if I don’t invest at least a little, all my readers assume it must be terrible. The other nice thing about a minimal investment (and minimal might be $25K-$200K in some of these funds) is that I can watch closely what it does for 2 or 3 years before deciding to invest a more significant chunk with them in the same fund or their next one.