The idea of passive income is prevalent—which is logical since the term refers to earning money without actually doing anything. That sounds too good to be true, and it is, but some income-producing activities require more involvement than others. For example, working at a job is one way to earn active income. On the other hand, investing can be either active or passive.
Directly investing in real estate is usually considered active income. The owner/investor is the landlord and must work to ensure the successful operation of the enterprise. For example, suppose you own one single-family home that you rent. You must manage the administrative aspects of the property, like the mortgage, taxes, insurance, tenant interactions, rent collections, maintenance, repairs, and more.
Many beginners are active real estate managers. Some enjoy the work, including the interaction with tenants. In contrast, others find it tedious or demanding (weekend calls about flooding or other urgent concerns can get old) and prefer to outsource some of the responsibilities. You can transition to more passive involvement if you hire a property manager to handle the day-to-day operations. However, you will pay some of your potential profits to delegate the work.
Real estate investments can be genuinely passive if you consider Delaware Statutory Trusts (DSTs) and Real Estate Investment Trusts (REITs). DSTs are legal entities structured under Delaware laws that allow investors to participate in the ownership of commercial property as a beneficiary of the trust with a proportional share of the potential earnings. A Sponsor creates the trust, identifies and acquires the assets, and distributes profits. However, due to the lack of liquidity and other risks, DST participation is open only to accredited investors.
Any investor can invest in a A trust that invests primarily in real estate, and passes the income, losses, and other tax items to its investors. Investments in REITs are classified as securities, and as such do not qualify for Section 1031 exchange treatment. Real Estate Investment Trust (REIT) . A REIT is a company that buys, sells, manages, and finances commercial real estate. There is a variant that invests in financial instruments like mortgages. Most REITs are publicly traded on securities exchanges and are available to non-accredited investors with smaller amounts of capital available for investment. Some private REITs require accreditation and larger buy-ins.
Active versus passive stock investing
Stock investors can also be active or passive. A passive investor typically purchases shares in an index fund or ETF (exchange-traded fund) that holds a wide range of stocks and seeks to match the performance of a specific index, like the S&P 500 or the DJIA (Dow Jones Industrial Average). You can choose the fund that aligns with your goals and leave it alone.
Passive investing in a mutual fund is typically less costly and less risky than choosing individual stocks in an attempt to beat the market performance. Passive investors don't sell frequently but instead take a long-term approach. Active investors may achieve higher returns but must devote more time and accept the higher risk.
Authored by Realized®.
Realized helps you exchange 1031-eligible investment properties for portfolios of commercial real estate that are customized to your shifting income needs, risk appetite, and investment goals across generations. By creating portfolios of fractional interests in Delaware Statutory Trusts (DSTs), Realized makes it easy to diversify investments across real estate sectors, geographies, and Sponsors.
Contact Realized to learn more about their due diligence and portfolio construction methodologies.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
All real estate investments have the potential to lose value during the life of the investment. All financed real estate investments have the potential for foreclosure.
All investments have an inherent level of risk. The value of your investment will fluctuate with the value of the underlying investments. You could receive back less than you initially invested and there is no guarantee that you will receive any income.
Programs that depend on tenants for their revenue may suffer adverse consequences because of any financial difficulties, bankruptcy or insolvency of their tenants.
No public market for DSTs currently exists, and one may never exist. DST programs are speculative and suitable only for Accredited Investors who do not anticipate a need for liquidity or can afford to lose their entire investment.
There is no guarantee that the investment objectives of any program will be achieved.
The actual amount and timing of distributions paid by REIT programs is not guaranteed and may vary. There is no guarantee that investors will receive distributions or a return of their capital. These programs can give no assurance that it will be able to pay or maintain distributions, or that distributions will increase over time.
Hypothetical examples shown are for illustrative purposes only.
A REIT is a security that sells like a stock on the major exchanges and invests in real estate directly, either through properties or mortgages.
REITs receive special tax considerations and typically offer investors high yields, as well as a highly liquid method of investing in real estate.
There are risks associated with these types of investments and include but are not limited to the following:
- Typically, no secondary market exists for the security listed above.
- Potential difficulty discerning between routine interest payments and principal repayment.
- Redemption price of a REIT may be worth more or less than the original price paid.
- Value of the shares in the trust will fluctuate with the portfolio of underlying real estate.
- There is no guarantee you will receive any income.
- Involves risks such as refinancing in the real estate industry, interest rates, availability of mortgage funds, operating expenses, cost of insurance, lease terminations, potential economic and regulatory changes.
This is neither an offer to sell nor a solicitation or an offer to buy the securities described herein. The offering is made only by the Prospectus.