Active investors are those who make their own investment decisions, while passive investors rely on a third party to do it for them. In real estate, there are many ways to invest in multifamily properties, but most of these methods fall into one of two categories: active or passive. Let’s take a closer look at each type of investor and how they approach multifamily investments differently.
Active Investor – An active investor typically makes his or her own decisions about which properties to buy and sell as well as when to buy and sell them. This person may also be responsible for overseeing the day-to-day operations of the property once it has been purchased by managing tenant relations, maintenance issues, etc. if he or she does not hire a property manager to handle this aspect of ownership instead. This is an extremely hands-on method that requires a significant time commitment from its owner(s).
Passive Investor – On the other hand, a passive investor may not be directly involved in making any decisions about an apartment building once it is acquired. This type of owner typically hires a professional management company or firm to handle tenant relations, all property maintenance and repairs, financial records, etc., leaving him or her free to focus on finding new investments instead. As its name implies (passive), this method requires little time commitment but often comes with higher fees.
As you can see from the two methods highlighted above, active investors tend to put in more time and effort than their counterparts who manage properties using a more passive approach do—and for good reason. Though they are rewarded by having more control over their investments, active investors face some added risks and costs as well.
Potential for Higher Returns – One of the primary advantages to buying multifamily properties using an active approach is the potential for higher returns on your investment. Remember, you are free to make all decisions about what, when, and where to buy or sell property—not a third party. That means that if you think the time is right to buy 100 units across town at 10% below market value with $0 down because it looks like rents in this area will climb quickly again over the next two years, then do it! Of course, there is no guarantee that rents will rise or that all tenants will pay on time (or even stay past their lease terms), but these are risks that active investors accept as part of their responsibility.
Risk of Personal Liability – Another drawback to actively investing in multifamily properties is the risk that you may be personally liable for some or all property debts and obligations. Even if you have an LLC or other business structure, your assets could still be at risk depending on the types of loans given out by a bank when securing financing for a property. For most investors with substantial assets, this concern does not outweigh the potential benefits from being more involved in managing one's investment(s). But it is something to keep in mind if you are thinking about entering into a multifamily transaction without professional guidance.
Costs Associated With Management – There are costs associated with hiring third-party management to oversee the day-to-day operations of a multifamily property—and these are additional costs that active investors often incur. These costs include professional management fees, utilities, repairs and maintenance, landscaping services, etc., all of which can be paid for with some or all rental income from tenants (depending on each agreement).
While passive investors may not experience anything like the same personal satisfaction as active owners do when it comes to managing their own properties; they also avoid some unique risks and costs associated with this more hands-on method as well.
Potential Risk of Low Returns – A major drawback to investing in real estate using a passive approach is that you may end up making less money off of your investment in the long run. Real estate markets tend to trend upwards over time, which is why active investors often see greater returns from their efforts when all is said and done.
No Direct Involvement in Management – Unless you take on a more active approach with your investments later down the road, a passive investor doesn't have to worry about personally dealing with tenant relations, making repairs, overseeing landscaping services, etc., throughout their ownership of an apartment building. Depending on each situation this may be viewed as a positive or negative aspect by prospective owners.
Easier System for Managing Investments – The last risk worth mentioning here is that using a passive approach to multifamily investing may provide access to lower rates and fees than one would receive if taking on more control of the buying process. For example, some lenders offer interest rates for loans that are better than what you would see with an active approach because they consider this to be less risk (higher chance of repayment). Of course, high rates and fees may not be a concern depending on how much cash you have to invest in real estate, which is why using passive investing alone as your only method of multifamily investing might not be enough.
If you are a passive real estate investor, but want the benefits that come from having more control over your investments, then you can always work towards obtaining this type of arrangement with each property you buy. For example, say you plan to buy and hold onto a multifamily investment property on the outskirts of a major city for the next 10 years.
Once you have obtained financing to buy this unit, you may want to oversee its day-to-day operations by hiring someone familiar with the area who knows how to manage rental properties effectively. You can then split up your property into multiple units and sell some off as time goes on (or keep them all for income).The idea here is that you can begin owning apartment buildings with a passive approach, but shift towards an active one in time—which provides the best of both worlds in this situation.
Possible/Probable Landlord Responsibilities
For those considering investment properties specifically to rent out to others, it's important to take note of what you likely must do in the eyes of the law. Owners (and their real estate agents) typically know that certain responsibilities come with owning and renting out a property to others, such as:
All these responsibilities are just part of owning and renting out a property, but there may be other obligations you have to adhere to as well. For example, if your newly purchased building is located in an area with local oversight boards or associations, then chances are good that you'll need to follow certain rules laid down by these governing bodies as well. Additionally, if you plan on living in one of the units yourself (or having someone else live there), then you probably won't have much choice about what laws apply to you, since they often pertain specifically to landlords who rent out their properties. The same goes for any residential tenant who decides not to pay rent from their side of things.
In short, the responsibilities of a landlord about renting out the property are made clear by law and regulation, but there may be other obligations that come into play as well. Whether you plan on working with a property management company, managing everything yourself, or selling off your units to another investor later on – it makes sense to know exactly what is expected of you legally before investing in multifamily properties.
After reading about both approaches to multifamily investing, it should become clear that neither passive nor active investors necessarily have the "best" or right way to make money off of their efforts. There are benefits and drawbacks associated with both methods, but after weighing these factors against one another many prospective investors may find that they are most comfortable taking on more active roles in their real estate ventures.
So, what's better? Active or passive investing in multifamily properties? The answer is generally "it depends." Do you have more experience as an active investor versus a passive one? If so, then you generally know your market well enough to make intelligent investment decisions. Thusly, you may wish to go with active investing because it can be lucrative if done right. However, if you are newer to real estate investing in general and/or multifamily specifically, then passive might be best for you since it allows you time to learn the ropes before jumping into the deep end of the pool. Only time will tell which option will ultimately serve investors better, but you can't go wrong with either one. If you are interested in investing passively, read our blog on A Deep Dive Into Apartment Syndication for an alternative way to invest passively in multi-family.