Should You be an Active or Passive Real Estate Investor, or Both?

Spring and summer are peak seasons for real estate transactions, with certain property types seeing higher activity due to favorable weather, school schedules, and market dynamics. Here are the most common types:

1. Single Family Homes
2. Condos & Townhomes
3. Vacation homes & Second properties
4. Multi-family properties

The property types above are common with active do-it-yourself real estate investors.  The commercial investable real estate market is much broader and has changed much over the past few decades.  Sectors such as industrial warehouses, senior living, cell towers and data centers have become more important and valuable sources of income and appreciation.

At Three Corners Capital, we appreciate the benefits of income-producing real estate for diversified portfolios.  Real estate in general has been an efficient asset class over time.  By efficient, we mean the potential returns for the level of risk are attractive relative to other asset classes.  Long-term price appreciation, steady and inflation-adjusted income, tax advantages, as well as the relative safety of owning real property are the main benefits.

There are two primary types of real estate investors:

1. Active Investors – These individuals directly buy, manage, or develop properties, handling tasks like maintenance, leasing, and financing.
2. Passive Investors – These investors put money into REITs, real estate funds, or partnerships without handling direct property management.

Many of our clients are passive-only investors in real estate (not including a personal residence) but some also own actively managed direct real estate.

What are the Pros & Cons of Active Direct Real Estate Investing?

Pros:

• Full Control – Investors make all decisions regarding property management, renovations, and tenant selection.
• Higher Potential Returns – Direct ownership allows for appreciation, rental income, and tax benefits like depreciation.
• Leverage Opportunities – Investors can use financing to scale their portfolio and maximize returns.

Cons:

• Time-Intensive – Managing properties requires significant effort, from maintenance to tenant relations.
• Higher Risk Exposure – Market downturns, vacancies, and unexpected expenses can impact profitability.
• Capital Requirements – Purchasing properties often requires substantial upfront investment and financing.
• Liquidity – When it’s time to sell, finding a buyer can be costly and take a long time.

What are the Pros & Cons of Passive Real Estate Investing

Pros:

• Hands-Off Approach – Investors earn returns without dealing with property management.
• Diversification – REITs and real estate funds provide exposure to multiple properties across different markets.
• Liquidity – Publicly traded REITs allow investors to buy and sell shares easily.

Cons:

• Limited Control – Investors rely on fund managers or REIT executives to make decisions.
• Market Volatility – REITs are subject to stock market fluctuations, impacting short-term returns.
• Lower Direct Tax Benefits – Passive investors don’t receive direct depreciation deductions or direct property tax advantages.

Integrate with Your Comprehensive Planning

In addition to the above pros and cons, it’s important to integrate real estate decisions with your overall financial planning.  For many people, their home is one of, if not the largest asset, in their net worth and holds personal, sentimental value.  However, for investment real estate (whether done actively or passively), the analysis should be void of sentimental or emotional value; the value is derived from the income, tax advantages and appreciation potential.

Liquidity is a crucial factor for direct investors.  One should fully understand that the market can change very quickly and converting the investment back into cash may not be an easy option when you want or need to sell.  While real estate enjoys several beneficial tax provisions when filing each year, upon sale of the property, capital gains may be larger than expected due to annual depreciation deductions.  We often help clients plan for and mitigate capital gain exposure through charitable giving and other tax planning strategies, such as a Section1031 exchange.  In short, this allows investors to defer capital gains taxes when they sell a property and reinvest the proceeds in a similar property.   Comprehensive and proactive planning can ensure that your other objectives and priorities are not compromised due to a direct real estate investment.