SS222: The Disadvantages of Passive Real Estate Investing

SS222: The Disadvantages of Passive Real Estate Investing

Every investment strategy has pros and cons. In this episode, Charles discusses some disadvantages of passive real estate investing.

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Talking Points:

  • Passive real estate investing offers a host of advantages to the investor, most notably passive income and time freedom. You can learn more about the pros and cons of passive investing by listening to episode SS111. Still, I want to focus this episode on the disadvantages of passive real estate investing—a topic I feel does not get enough coverage.
  • I have been a passive real estate investor since 2018. Over the years, while investing with multiple operators and in multiple deals, I have found that I have done best investing passively in single syndication real estate deals. I once ventured outside of real estate and lost money, so since that time, I have specifically focused on real estate deals with seasoned operators, mainly multifamily. I have tweaked my investment philosophy during my passive investing career to help me become a better passive and active investor. Let’s break down some of the disadvantages I have found with passive real estate investing.
    • 1. Minimal Control. Passive investors do not have any say in property operations or the execution of the business plan. All decisions, including tenant screening, marketing, property management, and renovations, are made by general partners.
    • 2. Illiquidity. This is not just a passive real estate investing disadvantage but possibly a real estate investing disadvantage in general; however, if you did actively own a rental property and needed cash, you could refinance it, take out a second mortgage, or possibly a line of credit against the property. However, in a syndication, this is not an option.
    • 3. Fees. Passive investments come with fees and profit-sharing splits that dilute overall returns. But you are entrusting your capital with a manager, and there must be an alignment of interest. This is most simply done by having all general partners invest in the deal alongside the passive investors while also earmarking a portion of profits to the GP when and if the deal is profitable.
    • 4. Dependence on Deal Sponsors. The success of the syndication depends solely on the operator’s team, including their property managers and contractors. If the operator is experienced and has been active in the market for years, this might be great; however, if the operator is a newer syndicator or new to the market, this can be a dramatic disadvantage to passive investors.
    • 5. Limited Transparency. Understanding what documentation, statements, and reports will be shared with investors is crucial to reviewing the progress of the investment. Certain general partners will not be forthcoming with this information, which is a red flag, especially if they initially said they would. When you are deliberating investing or not, ask how their reporting works, when it happens, and what will be provided. Any lack of transparency makes it difficult to assess the performance of any investment.
    • 6. Fraud. Fraud and Ponzi schemes are always a possibility when you are passive investing. I believe Ponzi schemes are much more probable with open-end funds that stay open for years, allowing people to contribute and withdraw funds throughout the fund’s lifetime. This becomes much more difficult with a single property syndication deal or closed-end fund where money is raised once and invested in 1 or more properties. Either way, fraud is always a possibility with passive investments.
  • Passive real estate investing can be extremely rewarding, but the passive investor’s work is done on the front end when performing due diligence on both the sponsor and the deal. Do not rely on the spray-and-pray strategy when passive investing. Trusting the operator and understanding the deal is paramount to success as a passive investor.

Transcript:

Charles:
Before we passively invest a single dollar in real estate, you need to listen to this episode about some of the hidden pitfalls of passive investing. Welcome to Strategy Saturday; I’m Charles Carillo, and today we’re gonna be discussing the disadvantages of passive real estate investing, passive real estate investing sounds great, passive income, less time commitment, not having to deal with tenants. But what if I told you also comes with serious downsides that most people don’t discuss. I’ve been investing passively since 2018 and after years of experience, I’ve learned the hard way, what works and what doesn’t. And if you’re thinking about becoming a passive investor or you’re already in the game, this episode is a must stick around. And let’s break down the risks, the red flags, and what you need to know before passively investing your money into a deal. So passive real estate investing offers a host of advantages to the investor, most notably passive income in time freedom, and you can learn more about the pros and cons of passive investing by listening to episode SS 111.

Charles:
That’s SS 111. So I wanna focus this episode on the disadvantages of passive real estate investing. A topic I feel does not get enough coverage. I’ve been a passive real estate investor since 2018. Over the years while investing with multiple operators and multiple deals, I have found that I’ve done best when investing passively in single syndication real estate deals. This means just single property deals, not funds, and I once ventured outside of real estate and lost money. So since that time, I specifically focused on real estate deals with seasoned operators, mainly multifamily, and I’ve tweaked my investment philosophy during my passive investing career to help me become a better passive and active investor. So let’s break down some of the disadvantages I have found with passive real estate investing. Number one is minimal control. So passive investors do not have any say in property operations or the execution of the business plan.

Charles:
All decisions, including tenant screening, marketing, property management, and renovations are made by general partners. Number two is illiquidity. Now, this is not just a passive real estate investing disadvantage, but possibly a real estate investing disadvantage in general. However, if you did actively own a rental property and needed cash, you could sell it, you could refinance it, take out a second mortgage, or possibly a line of credit against the property. However, in a syndication, this is not an option. Number three are fees. Past investments come with fees and profit sharing splits that dilute overall returns, but you were entrusting your capital with a manager and there must be an alignment of interest. This is most simply done by having all general partners invest in the deal alongside the passive investors, while also earmarking a portion of the profits to the GP when and if the deal is profitable.

Charles:
Number four is the dependence on deal sponsors. Now the success of the syndication depends solely on the operator’s team, including their property managers and contractors. If the operator is experienced and has been active in the market for years, this might be great. However, if the operator is a newer syndicator or new to the market, this can be a dramatic disadvantage to passive investors. Number five is limited transparency. Understanding what documentation, statements, and reports will be shared with investors is crucial to reviewing the progress of the investment. Certain general partners will not be forthcoming with this information, which is a red flag, especially if they initially said they would. Would. When you’re deliberating investing or not, ask how the reporting works when it happens and what will be provided. Any lack of transparency makes it difficult to assess the performance of any investment. Number six is fraud.

Charles:
So fraud and ponti schemes are always a possibility when you are passive investing. Now, I believe Ponzi schemes are much more probable with open-end funds that stay open for years, allowing people to contribute and withdraw funds throughout the fund’s lifetime. That means that you’re robbing Peter to pay Paul type of situation. As money comes in regularly, it also goes out regularly. It makes it much more difficult to understand how profitable or how successful the fund is the investment is. But this becomes much more difficult with a single property syndication deal or a closed in fund where money is raised. Once it’s invested in one or more properties and there’s maybe some distributions, and then at the end of it, the bulk of it comes out, it’s much harder to run the Ponzi scheme model with that. However, either way, fraud is always a possibility with passive investments.

Charles:
Now, passive real estate investing can be extremely rewarding, but the passive investor’s work is done on the front end when performing due diligence on both the sponsor and the deal. Do not rely on the spray and pray strategy when passive investing, trusting the operator and understanding the deal as paramount to success as a passive investor. So I hope you enjoyed it. Please remember to rate, review, subscribe, submit comments and potential show topics@globalinvestorspodcast.com. If you’re interested in actively investing in real estate, please check out our courses and mentor and programs@syndicationsuperstars.com. That is syndication superstars.com. Look forward to two more episodes next week. See you then.

Charles:
You always want to invest in real estate but didn’t have the time, didn’t know where to find the deals, couldn’t get the funding and didn’t want tenants calling you. Since 2006, I’ve been buying income producing properties in great locations that provide us with consistent passive income while we wait for appreciation in the future and take advantage of tax laws while we’re waiting. And unlike your financial advisor, we invest alongside our investors in every property we purchase. Check out and invest with harborside.com. If you like the idea of investing in real estate. If you like the idea of passive income, partner with us investwithharborside.com. That’s investwithharborside.com.

Speaker 3:
Nothing in this episode should be considered specific, personal or professional advice. Any investment opportunities mentioned on this podcast are limited to accredited investors. Any investments will only be made with proper disclosure, subscription documentation, and are subject to all applicable laws. Please consult an appropriate tax, legal, real estate, financial, or business professional for individualized advice. Opinions of guests are their own information is not guaranteed. All investment strategies have the potential for profit or loss. The host is operating on behalf of syndication Superstars, LLC exclusively.

Links Mentioned In The Episode:

  • SS111: Active vs Passive Real Estate Investing

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