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DEFINITIVE GUIDE FOR PASSIVE COMMERCIAL REAL ESTATE INVESTING

Passive Real Estate Investing: Introduction

In this day and age, passive real estate investment is where it’s at. Whether you’re at a cocktail party, a country club, an investment forum, or a conference for self-improvement, real estate is bound to come up at some point. We, as a nation, have an insatiable interest in the property market. According to a survey conducted by Bankrate.com, more people choose to put their money into real estate than any other type of investment.

Real estate advice from every possible source is available at the touch of a button, whether you’re tuning into your favorite podcast or browsing the shelves of your local bookshop. You’ve probably heard about the latest and greatest way to make rich with real estate through late-night television infomercials or weekend seminars advertised on the radio.

Numerous people are exploring alternatives to the stock market to diversify their holdings and generate additional income or are searching for a side business to generate more passive income.

Everyone may be interested in real estate, but getting started can be challenging. This book aims to help you become a more well-informed real estate investor to make the best decision possible.

Passive investment in real estate can help you reach your financial objectives, whether to increase your income or to protect and diversify the money you’ve already amassed.

Why Invest Passively in Real Estate?

Investment experts and financial planners recommend putting 20–50% of your wealth into real estate. Although the ideal proportions of various asset classes will vary from one person to the next, there’s no denying that real estate holdings can and should constitute a sizeable component of any diversified portfolio.

  1. Insurance Against Inflation

Can you recall a time when a gallon of gas cost less than $1? Because of inflation, the purchasing power of a dollar decreases as the cost-of-living rises. Savings account interest rates are currently under 0.01 percent, while inflation over the past 20 years has averaged approximately 2 percent. This means that your money is losing value while it sits unused. Multifamily and self-storage leases and long-term commercial leases with built-in rent increases are excellent real estate investment vehicles for mitigating deflationary inflation. You might expect to collect a higher rent payment in proportion to the growth in your operating costs. The real estate market provides a hedge against inflation that is useful for active and passive investors.

  1. Leverage

Buying stocks worth $100,000 requires $100,000 in cash (not counting margin, although most investors are advised against utilizing it for long-term investment). However, real estate is primarily a gamble with the lender’s money. In a typical real estate transaction, a mortgage may cover as much as 80 percent of the purchase price, reducing the outlay from $100,000 to around $40-60,000. Investors might acquire properties with market values significantly over their initial investment by taking on debt. Changes in income and values have a multiplicative effect on starting funds. For example, if the cash-on-cash return of an investment property is 8% and the buyer takes out a loan for 50% of the purchase price, the return will increase to 16%. (Double check the math).

  1.   Diversification

Property values are independent of the ups and downs of the stock and bond markets. Stock and bond prices aren’t usually a good indicator of future real estate value because they rely on the underlying economy and population. Surprisingly, some types of real estate can even increase in value amid a recession and stock market downturn.

 

  1.   Consistent Expansion

In the same way that real estate is not dependent on the stock market, its value does not fluctuate similarly to shares. The stock market is a constant game of give-and-take, as any investor will attest. Circular motion, going up one day and down the next. Due to its illiquidity, real estate asset prices cannot and do not fluctuate similarly to stock market prices. When investing in real estate passively, there is no need to monitor the market to ascertain the value of your holdings.

  1. Appreciation

Long-term real estate appreciation is typical, and a proactive operator can even induce short-term appreciation. The primary component in evaluating a property’s value is its net operating income, which rises when rental income rises and running expenses fall.

  1. Equity Buildup

The accumulation of equity is a benefit exclusive to purchasing real estate using leverage. Your monthly income and the amount paid toward the mortgage contribute to a rise in the equity you have in the investment. This implies that the windfall you receive when you sell the investment will also be greater. This is essentially the same as having your tenants contribute money to a savings account you have for yourself.

Tax Advantages of a Passive Investment in Real Estate

Passive Depending on the investment structure, the passive investor can reap the benefits of real estate’s favorable tax treatment.

Since real estate is taxed similarly to a corporation, all costs directly attributable to managing the property are deductible. Expenses such as repairs, wages, and advertising are included in this category, and the usual suspects like property taxes, insurance, and interest. All of these tax breaks are great for a passive real estate investor.

  1. Depreciation. Both active and passive real estate investments can greatly benefit from depreciation in tax liability. Depreciation, in a nutshell, is the practice of writing off a portion of an asset’s value as a loss due to the asset’s deterioration or obsolescence. This is the case even if the property’s value increases over time.

When there is no corresponding cash outflow, depreciation expense is nevertheless deductible against taxable income. Due to the magnitude of these outlays, the property may record a taxable loss despite generating positive cash flow for the investor.

Just try doing it with your stock and bond portfolio!

  1. Get Through Losses. Suppose your investment in passive real estate yields passive losses. In that case, those losses can directly counterbalance any passive gains you may have accumulated due to engaging in other types of investment activities. Additional passthrough deductions are available to business owners under the Tax Cuts and Jobs Act of 2018, passed in 2018. Qualified business income is required (QBI).
  1. Accumulated Profits. The earnings made from the sale of real estate are subject to a tax known as the capital gains tax by the government. If the investor bought and sold the property within one year (referred to as “Short Term Capital Gains”), then the gains are subject to taxation at the investor’s usual rate. If, on the other hand, they held the property for more than one year, then long-term capital gains rates apply. These rates can be significantly lower than those that apply to ordinary income.
  2. 1031 EXCHANGES. A 1031 exchange allows investors to defer taxes on long-term capital gains even further than the relatively low rates currently. It could write a whole book on the topic, but the gist is that if you promptly make a new real estate investment after selling one, you can delay paying capital gains tax. A 1031 exchange is an option, but there are many rules to follow, so it’s important to get advice from an expert.

One of the main features of a passive real estate investment is the potential tax benefits it might provide. We could discuss each of the above tax advantages in greater detail.

Tangible Assets Like Real Estate Are Important

Real estate is a visible and understandable asset class in which to invest. You shouldn’t discount the psychological advantage of having a physical representation of your investment. While it doesn’t improve profitability, it is nice to know that you can stop by an investment anytime and see how things are going.

Investing In Real Estate: Why Passive Strategies Outperform Active Strategies for Most Investors

Do you want to invest in real estate to get monthly passive income? While it is undeniably a great perk of real estate investing, it is no longer a passive activity. While there are many advantages to having a stake in the real estate market, passive income is not one of them.

You need to invest more time and effort in investing in real estate. You will be conducting market research and analyzing a large number of agreements. You’ll be responsible for choosing which business opportunities to pursue and which to pass up.

It’s not easy to invest actively. Most of the real estate’s upsides are enjoyed by passive investors, with none of the hassles.

  1. Landlords Are Not Required for Passive Real Estate Investors

When investing in real estate passively, you don’t have to worry about the most time-consuming yet crucial tasks. You won’t have to worry about the time and effort required for tenant screening and management. If you’re a passive real estate investor, you also won’t have to worry about collecting rent from tenants who haven’t paid on time. An active investor, regardless of the quality of their renters, will eventually have to go after rent.

You’ll still invest time and effort as an active investor, even if you hire a property manager. You are the manager of managers. This necessitates regular contact, perhaps once a week—approval of continuing financials or review of proposed capital improvements. Daily struggles will be heard about but not experienced. You and your property manager should continually communicate about fixing and improving issues.

  1. Maintain Tax Advantages

Many of the tax benefits associated with active ownership are preserved when investing in passive real estate. For example, when you invest in a real estate syndication, you get many of the same tax benefits as if you owned the property outright.

  1. Not Required to Find Deals

It’s challenging to locate discounts. Investors seeking new prospects usually have a specialized staff to find promising new investments. Active investors should cultivate close ties with vendors, brokers, and managers. You need to be at the front of their minds, so they immediately think of you when a chance presents itself. A serious investor may look at hundreds of opportunities before finding one that meets their standards. You must review the promising leads that cut if you’re a passive investor.

  1. Avoid Obtaining Loans

The cost of property is very high. You won’t enjoy the perks of a $20,000,000 real estate investment if you can’t afford to make the acquisition. Groups of investors can pool their resources to acquire a valuable piece of property that would be out of reach on their own.

When investing in real estate passively, investors can avoid having their names attached to any legal paperwork or promises. From a security of possessions point of view, this is essential. Signing a recourse loan guarantee exposes your entire financial portfolio to potential losses if the deal fails. Passive investors do not take on that risk unless they voluntarily take it and are compensated for doing so.

  1. Benefit from the Expertise of Others

In the same way that any other business has prospects, daily operations, and administration, real estate investing also has successful real estate investing requires treating your investment portfolio as a business. You’ll need operational metrics and key performance indicators to keep tabs on progress.

The most successful investors strictly adhere to a system governing every portfolio aspect. If you don’t have the time or energy to put these processes in place, it’s in your best interest to work with someone who can.

Owning real estate outright and actively is a terrific way to earn money. Don’t mistake it for a form of passive property investment. Direct investors typically transition into the field full-time. You can burn out if you don’t pay attention. One should concentrate on their strengths and hire specialists for the rest. You can invest passively in real estate with a skilled operator while focusing on your day job if you’re a doctor, lawyer, or business owner.

Having a passive investor’s mindset and strategy when directly owning a business is a common investing blunder. Investments made directly need regular monitoring and attention. Ignoring the day-to-day tasks of operating and maintaining a property is a surefire way to invite a distressed sale.

Alternatives For Passive Real Estate Investment

If you’ve read this far, you’ve probably concluded that including some passive real estate investments in your investment portfolio is smart. Let’s go over some of the ways you can make it happen so we can get started.

Investing Passively in Real Estate Through REITs

REIT: Introduction

Investing passively in real estate through a REIT or Real Estate Investment Trust is perhaps the simplest way to get started. Most readily available are publicly traded REITs, which can be bought and sold on the same day as any other stock. Remember that a real estate investment trust (REIT) is not the same as owning a piece of the actual property but rather investing in a business whose primary business is real estate. The tax implications and other factors are affected by this.

Equity real estate investment trusts are corporations that acquire or invest in real estate ownership interests. Mortgage REITs invest indirectly by purchasing debt or real estate-related debt securities. REITs can be subdivided further to focus on certain real estate market segments. There are real estate investment trusts (REITs) for every type of property imaginable, including but not limited to office buildings, factories, homes, storage facilities, and even computer centers and forests.

More than 75% of a REIT’s assets must be in real estate, and the corporation must distribute at least 90% of its taxable income to its shareholders as dividends. As a result of this stipulation, REITs typically provide greater returns than the majority of stocks.

A REIT can deduct dividends from income tax if the company satisfies these conditions. This means that real estate investment trusts (REITs) can boost their cash flow available for distribution to shareholders while paying minimal or no income tax.

 

Benefits of REITS:

  1. Simple to Implement. Logging into your brokerage account will provide instantaneous access to purchasing real estate investment trusts (REITs) or trust index asset funds. Similar to investing in the stock market.
  2. Exhibiting Stock-Like Liquidity. You can immediately liquidate real estate investment trusts (REITs) if you need rapid cash. That’s why real estate investment trusts (REITs) are a smart choice for quick access to the real estate market.
  • 3.      Diversification. Real estate investment trust (REIT) assets are corporate investments. Thus, their shareholders have diversification throughout the REIT’s portfolio of properties.

 

Drawbacks of REITS:

  1. The Inability to Select a Property. Investment in real estate through a REIT is considered passive investing because the investor has no say over which properties are included in the portfolio. Investor can tailor their real estate portfolio to meet their specific needs and objectives through either active or passive participation in a real estate syndication.
  1. Not All Tax Breaks Are Available. Ordinary income tax rates are the highest, and dividends from real estate investment trusts (REITs) are the worst sort of income in terms of taxation. A smart move is to keep all REIT holdings in a tax-deferred retirement plan like an IRA. The main tax benefit of real estate is that investors can deduct expenses like mortgage interest and property taxes.
  1. Multiplied Fees. While some real estate investment trusts (REITs) have a straightforward fee structure, others rely heavily on nested fees for their managers’ take.
  1. The Stock Market Is Used to Determine Values. The values of real estate investment trusts (REITs) are highly connected with those of the stock and bond markets. The value of a REIT’s stock might rise or fall in response to shifts in investor sentiment and stock market prices.

 

Using Syndicated Real Estate Investments as A Passive Investment Strategy

 

Real Estate Syndications: Introduction

Syndicating real estate is nothing new, but it has recently gained popularity. The term “syndication” refers to the practice of several investors pooling their resources to acquire a major commercial or multifamily facility. Regarding funding projects, real estate investment firms and developers have relied heavily on syndication for decades. One of these non-traditional investing options was previously difficult to get by. Sponsors were prohibited from promoting or discussing deals with anybody outside their immediate contact’s circle. One needed either insider knowledge or a referral to gain in. Funding for deals would occur at social events at country clubs.

As a result of new rules, deal sponsors can publicly promote their services without fear of repercussions. Thus, people have gained a broader understanding of this investment strategy.

Inactive Real Estate Investments Distribution through syndicates can be as broad and varied as you choose. A suitable syndication opportunity exists regardless of an investor’s risk tolerance, return expectations, or preferred investment style. A wide variety of agreements are available, from stable, low-return ventures backed by investment-grade tenants to speculative, high-risk hotel complexes seeking 30 percent returns.

Syndications might involve the purchase of a single asset or pooling capital to pursue several opportunities within the same investment concept.

 

Syndications Pros

  1. Greater Returns Than REITS Are Possible. Compared to other forms of passive real estate investment, the return profile of syndication is typically the best. In many cases, the expected rate of return on a value-add remodeling project is fifteen percent or more. New construction transactions typically promise annual profits of twenty-five percent or more to interested financiers.
  1. Gaining Entrance to Transactions That Would Be Too Large for You to Handle Alone. There is a growing interest in real estate syndications because they allow ordinary people to own property that would otherwise be out of reach. Class A properties often attract syndications of $10-50 million. The local MLS doesn’t always have the best properties available, but syndication can help you get your hands on some of the best ones.

3.      Protection of Liability. However, just because you can handle the bigger situations alone does not indicate that you should. If you invest passively in syndication, your financial exposure will never exceed the amount you initially invested. Passive shareholders will not be held liable if the asset holding company is sued or a loan guarantee is executed.

 
  • Use the Knowledge of Experts to Your Advantage. A passive investor does not require real estate expertise to participate in a real estate syndicate. You will have an expert manage the investments and properties for you. Even if you consider yourself a savvy investor, it’s still a good idea to bring in a professional who can provide fresh insight and apply strategies to boost returns or, at the very least, reduce the likelihood of a deal going awry.
  • Passive Real Estate Investors Benefit from The Tax Advantages of Direct Ownership. Getting the same tax benefits as a direct owner is a major perk of syndications. Because you have an ownership stake in the company that owns the property, in the event of a paper loss, it can be offset by a paper gain from another passive investment. If you can prove that you are a real estate professional, you will be able to deduct business expenses from your income.

 

Syndications Cons

  1. Not Liquid. Never risk cash that you need right away. Hold durations for passive syndications average between three and seven years. Investors are not repaid until the property is sold, though payouts are common in many agreements.
  1. Fat Capitalism. Standard syndication minimums range from $50,000 to $100,000. Some transactions have minimums of over $1,000,000, while others have minimums of under $25,000.

How About Crowding?

Rather than becoming a new product, web portals provide a new channel for advertising existing syndications.

Some online platforms advertise to non-accredited investors and accept initial investments of less than $500, thanks to new regulations.

High costs are due to the intermediary nature of the portals between investors and deal sponsors.

There will be no variety in sponsors, as only those with contracts with the portals will be allowed to participate.

Private Lending for Passive Real Estate Investment

Private Lending Introduction

The term “private lending” refers to situations in which the lender is not a financial organization like a bank or credit union. Private investors provide capital to a real estate firm through a one-on-one transaction or a group of investors.

Short-term bridge finance in the form of private loans is common. Value creation allows the loan through a sale or refinancing quickly. Putting up the property as collateral for a private loan is a relatively safe investing strategy. In nonpayment, the lender may exercise their right to foreclose and sell the collateral to recuperate their losses.

 

Perks Of Private Lending

  1. Having Access to Leverage. Many private lenders will take out a loan against their home equity or some other line of credit at a low-interest rate and then lend to real estate speculators at a much higher interest rate. A person’s retirement savings can also be used in private lending. Investing directly in real estate would be impossible without access to these funds.
 
  1. Short-Term Investments. It’s not uncommon for the term length of a private loan to be a year or less. This provides greater liquidity than standard syndication but less than a real estate investment trust (REIT)
  1. Nice Risk to Reward Ratio. The average annual return on private lending is between 5% and 12%. Also, the added safety of a mortgage on the property makes this a solid option. The returns on many stabilized equity investments are comparable even without collateral.
  1. There Is No Obligatory Paperwork or Monetary Costs. Before any funds are sent to the borrower, an attorney will draft all the appropriate agreements to safeguard your investment. Lenders typically pass on attorney costs to borrowers at closing.

Risks Of Private Lending

  1. It Is Difficult to Find a Consistent Flow of Deals. The single-family fix-and-flip industry accounts for most passive investments through private loans. Finding private lenders willing to finance commercial or multifamily real estate deals is more challenging. A private loan can be a good option if you have few funds to invest, but many other options are exhausted. Many houses’ flippers only complete one or two transactions per year, making it difficult to find investors who can provide a steady stream of opportunities.
  2. Needs Constant Involvement and Monitoring. Private lending entails less hands-on management than outright ownership but more work on the front end and in the long run compared to passive assets like real estate investment trusts.

 

Investing In Notes as A Passive Real Estate Investment

Investing In Real Estate Notes: A Primer

In the same way, private lending is analogous to passive investing in real estate notes. When you buy a note, you purchase the loan from the original lender. There are a variety of situations in which investors can decide to purchase notes. A lack of deal flow could prevent you from becoming a debt investor. And even if you do find loan opportunities, they may not be a good fit for your deal profile.

First and second position notes are available to the passive investor in real estate notes. The first position offers the highest degree of safety but yields the least money. Less secure jobs typically pay more than their first-place counterparts. It is not uncommon to find second position notes priced below face value.

You get complete control over your risk and return as a passive note investor. It is possible to buy both interest-paying and non-interest-paying notes. The borrower is considered performing if they are either current on their payments or are not in arrears. They are not performing up to par.

Values for performing notes typically hover around par. Based on the specifics of the default, they can purchase nonperforming notes at steep discounts to the outstanding principal. When you buy a nonperforming note, you can turn it into a performing note by entering into a workout agreement with the borrower. If that fails, foreclosure is an option for regaining property ownership. Buying bad notes requires more of an active approach. Most passive real estate investors don’t want to deal with the additional labor involved in investing in notes.

How to Acquire Notes?

Opportunities for note buyers typically arise from seller-financed deals. These sellers are looking to cash out after selling their homes on favorable terms to the buyer. For note holders, selling their notes results in a lump sum payment rather than monthly interest payments.

Notes on real estate are available on markets like notes direct and paper stack. Attorneys specializing in real estate law can also be a good resource for finding deals. Mailings to people’s homes are effective as well. You can construct a list of prospective note sellers using a data firm like a list source.

Mortgages held by banks and credit unions are often sold off to satisfy rules and increase liquidity. Individuals’ purchases of such passive investing opportunities were once rather prevalent. Purchasing directly from a bank is now highly unusual. Financial institutions typically package several loans together into a portfolio before selling it to a hedge fund.

Upsides of Investing in Notes

  1. Possibility Of Greater Gains. Returns are magnified if performing notes may be purchased at a discount to face value. It’s not uncommon for a note seller to demand immediate payment.
 
  1. Alternative Route to Homeownership. The majority of note investors only buy bad notes. The assumption is that it can purchase a note at a steep discount to the property’s market value. After the foreclosure, they will take ownership of the asset at a steep discount. I wouldn’t call this approach passive, but it is effective anyway.

 

Downsides of Investing in Notes

  1. Constrained Number of Transactions. Finding transactions and deal flow can be challenging at first. There is a lot of groundwork before you can begin investing in notes, as this is a specialized field.
  1. Acquired Expertise. A specialized skill set is needed for note investing. You will have to educate yourself on the art of loan underwriting. There is a large supply of notes on the market, many of which come from small-time sellers who didn’t negotiate favorable terms when they first got the loan. A note listed for sale does not guarantee that it is a smart investment.
  2. Not Liquid. Real estate notes can be difficult to sell if you need immediate cash. Private loan agreements have a longer term than notes. Your return on investment will be reduced if you have to sell quickly. Taking home to foreclosure court can be lengthy if that is your intended outcome.

 

Turnkey Properties

An Overview of Turnkey Investments

In turnkey investing, a third party handles all the administrative and operational details so that you can focus on making money. Service providers source acquisitions, retain construction workers, oversee the renovation and tenancy, and handle ongoing property management. You get all the benefits of property ownership while others do the heavy lifting. This is a fantastic idea, but it’s not always effective in practice.

Gains To Investing in Turnkey Properties

  1. Direct Ownership. Turnkey homes put you in the position of the sole proprietor. This implies you’ll be eligible for advantages, such as tax breaks and increased equity. Because of this, you will also need to increase your level of physical activity.
  2. Involving Minimal Financial Outlay. The majority of turnkey investments are single-family homes that are rented out to tenants. They typically cost less than major commercial or multifamily developments. Traditional financing options also exist, allowing you to make the most of your capital.

Negatives To Investing in Turnkey Properties

  1. Control Issues. If you desire a return on your investment, turnkey properties aren’t completely hands-off. The manager needs to be managed.
  2. Overpaying. The price is usually the main issue with turnkey properties. Providers offering a “turnkey” service sell pre-existing, renovated residences. They are counting on advertising to draw in customers in large numbers. Their benefit outweighs the buyers in this case. There are situations when the comparables don’t back up the asking price.

Typically, Only One Household. One of the main advantages of passive real estate investing is the increased scalability it provides. Typically, turnkey homes are single-family dwellings that are rented out to tenants.

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