Jan 15, 2023 5 min read mastery

Passive Investing Introduction

“If you don't learn how to earn money while you sleep, you will work until you die.”
Warren Buffet

Do you want to be the driver or the fuel?

There are two main ways to bring cash flow into your life to pay for cash expenses. The first is through active engagement with a business process - similar to being the driver of the car. Being the driver is a pretty familiar role, since that is the daily experience of most of us - earning wages or fees in exchange for work performed. Active engagement means that you yourself show up and perform a task, direct others, practice a skill, etc. Even if you delegate much of the work to others as a business owner or corporate executive, your active involvement is needed to make things happen.

The second category is passive involvement, providing resources rather than operating the business - similar to being the fuel for the car. Passive investors might provide funds to acquire real estate, purchase bonds that fund a municipal improvement project, buy shares of stock in a publicly traded company, or loan money to an entrepreneur. Passive earning commonly happens by first saving up money received as wages, then placing that money with others in exchange for the outputs of their activities - making the money earn the money. I’m saying money, but it could be other kinds of resources such as land, a patent, a web property, a building, water rights, etc. A passive investment means you yourself are not involved in day to day decision making - cheering from the sidelines as the company either thrives or flounders.

A mindset shift

Leaving the driver’s seat and taking a behind-the-scenes role is a shift in self-concept for most of us, but since there are a fixed number of hours in each day, using passive investing to amplify the results from your prior efforts is a key practice for gaining control of your time. Otherwise, you must continue trading current effort for current income.

The difference between being the driver and being the fuel is important to keep in mind, and I’m stressing it because in real estate investing, active options are well known - owning a home that you rent to tenants, owning and operating an RV park, owning and operating an apartment building, etc. These are the kinds of activities that spring to mind when someone considers a leap into real estate investing. But a sneaky attribute of each of these options is that the buyer is taking on two distinct roles as both the owner/fuel and the operator/driver. I’ve seen many beginning investors who are initially attracted to real estate investing due to its potential as a profitable side-hustle, who may have tremendous existing demands on their time, but who choose active real estate investments due to not knowing about passive ones. Taking on active operation of an additional business can be overwhelming and may result in being turned off to the whole concept of investing, or burned out, or juggling so many balls that the property is not maintained well and becomes a drag to own. I have seen friends who intended to get into investing as a side income stream but after a while realize that they’ve bought themselves another J O B. Contrast this with passive investing, which is much easier to balance with other commitments.

Common passive real estate investment structure

Real estate passive investing is a way to join forces with others to purchase and operate real estate based businesses. It could be an apartment complex, self storage facility, shopping mall, industrial building, etc. Similar to holding shares of a company, as a passive investor you are not involved in the day to day running of the business, thereby leaving your time open for other pursuits. A name commonly used for this kind of investing is a syndication, but don’t let that name turn you off to the concept. A typical structure for a syndication goes something like this:

A new company is formed with a fixed number of shares for sale. The company’s sole purpose is to buy and operate a specific property. The ownership of the company is divided into 2 bands or classes of shares: one band owned by the active participants (the folks who will search for, inspect, acquire, manage, and make all decisions about running the property) and a second class for passive investors.
Any earnings from the business are divided up according to a pre-agreed ratio laid out in the operating agreement, such as 70% to the passive investors and 30% to the operators.
A particular investor may have contributed, say, $50,000 out of a total of $5,000,000 for the purchase expenses, then receives the equivalent proportion of the operating profits, which would be .01 of 70% of the profits in this example.
The active participant entity (also called sponsors or operators) have sole discretion whether to keep operating the business or close it. If the single property is sold, the company is dissolved and earnings from the sale distributed to all shareholders according to a pre-agreed ratio.
If the business runs short of funds (out of fuel), passive investors might be required to cover the shortfall, again according to a procedure spelled out in the operating agreement.

How do I get started?

Getting started understanding how passive real estate investments work is a similar learning curve as the other better-known method of passive investing: buying shares of publicly traded companies. To earn money with this strategy requires spending time evaluating offered stock shares. The investor needs to assess the financial health of the company, whether the product it sells seems in demand or in decline, and the price currently asked for the shares, among other things. Learning and practicing this evaluation skill can take a lot of time. So even though the investment is passive, there are still crucial tasks to learn before initiating the investment. After investing, the investor should spend some time monitoring its performance.

Similarly, a successful passive investor in real estate must spend time understanding how to assess a project and the people who will run it, and also spend at least a little time after it is purchased staying informed about the investment performance. Developing confidence in your ability to interview the active operators of a business and identify good projects is a prerequisite. Just like in a stock market investment, gaining this understanding is possible for you, and worth the effort! Investing in syndications can produce good returns, typically has more transparency about the business operations than a publicly traded company, and follows a different market cycle than the stock market. It can be a key piece of gaining traction toward financial freedom.

Check out these resources to learn more

I am frequently asked where did I find the syndications that I invested in. The answer is NETWORK NETWORK NETWORK LEARN LEARN LEARN. I’ve spent a ton of hours listening to investor education podcasts and going to in person meet ups to not only build up my knowledge but also to connect with other investors that I can bounce questions off of. There are dedicated education resources that can help you get familiar with passive investing and the wide range of investment property types.

Here are some recommended starting points.

Podcasts that discuss syndications

Michael Blank interview with: Ellie Perlman, Raj Tekchandani, Monick Halm
Joe Fairless interview with: Matt Shamus
Bigger Pockets interview with Mark and Tamiel Kenney
Lisa Hylton interview with Jeff Greenberg

Youtube educational webinars

Passive opportunity platforms:

Crowdstreet

In a follow up article, I’ll provide some criteria for assessing syndication opportunities.