If you’ve dreamed of financial freedom but consider it to be an impossible dream, I’ve got good news for you. Financial freedom is not only possible, it’s realistic and attainable. It doesn’t happen by accident. Becoming financially independent requires a plan.
That plan should include learning how to get started with passive real estate investing.
Real estate investing is a tried and tested method for creating passive income. According to Forbes, real estate investing builds wealth more consistently than any other asset class. Real estate investing has made more millionaires than any other asset class. A comparison of all investment asset classes reveals that over the last 100 plus years, real estate is the top performer.
There’s more good news. You don’t have to be a millionaire to get started. To start a passive investment real estate plan, you do need some money. Many people, though, are surprised at how little it takes to get started in passive real estate investing. People are further surprised to learn that they already have the money it takes to create a passive income investment plan that generates residual income. Later in the post, we’ll discuss the many ways you already have to invest in passive real estate cash-flowing property.
What is Passive Real Estate Investing?
Most people think that real estate investing is anything but a passive investment. The perception many people have of a real estate investor is a person who owns and manages rental property or buys to fix and flip. The picture this brings to mind is tenants, toilets, and trash. The three big “Ts” spell trouble, trial, and torment. These are three frustrations that all successful and fulfilled professionals and entrepreneurs want to and should avoid.
There is an alternative. One does not have to be a landlord or fix and flipper to receive real estate investing benefits. The tax benefits and regular cash flow that generate residual income from real estate rental property are attainable through passive real estate investing.
Passive vs. Active Real Estate Investing
One way to think about the difference between active and passive Real Estate investing is to understand the degree of involvement with the property.
Owning a rental property is active investing if you’re self-managing. While passive investing is where properties are usually managed by a 3rd party. Examples of passive investing include syndications or REITs (Real Estate Investment Trusts)
In terms of Real Estate Syndication, the active investor puts up their time and labor. The passive investor puts up their capital. The two will then share in the profits.
The real estate syndications that are referred to in this article are more complex than this simple illustration. No matter how complex the organizational structure, the fundamental principle remains the same. The blog post Is Real Estate Syndication Suitable for a Passive Investor illustrates more fully the differences between an active real estate investor and a passive investor.
What Should I Invest in For Passive Income?
The most common passive investment class is the stock. Working people with retirement accounts are familiar with stocks as retirement funds are generally invested in stock and bond markets. The retirement fund manager trades these assets on the various stock exchanges.
The Wall Street Stock Exchange is one example.
The advantage to investing in the stock market, either as a private investor or through retirement funds, is the convenience. Stock investments are both passive and liquid. These assets are publicly traded through an exchange. Therefore, the stock investor is allowed to buy and sell at will. It is so passive that it is possible to put the stock certificate in a safe deposit box, ignoring it for years while it grows in value.
Real estate cannot be ignored. An ignored property will devalue rather than increase to produce a positive return on investment. Someone must take care of the real estate investment property. That someone is the active real estate investor, not the passive real estate investor.
These differences between stock market investing and real estate investing are significant, but in many respects, they are not that different. Stock investments and passive real estate investments are both securities.
When you invest in a stock, the security you subscribe to is the stock certificate. When you invest in real estate, the security you subscribe to is a Limited Liability Company (LLC) or a Limited Partnership (LP) membership. Both stock and real estate securities are regulated by the Securities and Exchange Commission (SEC).
The difference is that the stock that most of us are familiar with is a public offering. The real estate interest is a private offering. It is not traded on a public stock exchange. There are plenty of differences, but for purposes of acquisition, this is the main distinction. For a fuller discussion as to the advantages and disadvantages of real estate versus stock investing, refer to the post: Which is Riskier? 5 Fiscal Reasons to Invest in Real Estate
How to Get Started with Passive Real Estate Investing?
For the busy professional who wants to maintain their chosen career and develop financial freedom, this difference between public and private offerings is significant. It takes no time to locate publicly offered securities. Finding private placement securities is intensely time-consuming. The difference in return on investment makes the real estate investment more attractive. Yet, the cost in terms of time and effort can be prohibitive.
Locating the Private Real Estate Securities for passive real estate investors is why Steed Talker Capital was founded. We make an arduous process easy by doing all the preliminary work. We locate the real estate investment offerings. Once potential offerings are located, we do the underwriting to ensure that the investment offering meets the qualification as a profitable investment. We make the offer and, if accepted, place the property under contract.
Thorough due diligence is conducted. Lenders are lined up. Finally, before closing, passive investors are subscribed.
To make the real estate investment as passive as possible, Steed Talker Capital brings the completed package to the potential investor. There are three parts to the offering package: Private Placement Memorandum (PPM), Operating Agreement, and the Subscription Agreement. Before subscribing, we walk each potential passive investor through the offering package.
Making your investment
To learn how to get started with passive real estate investing, developing an understanding of the three components is essential. Your first step before investing your funds is to thoroughly review these offering documents. When you understand these documents, you are ready to start investing in passive real estate. Steed Talker Capital systems make the process seamless and easy.
This section explains what each contains and illustrates the importance of the information to the investor.
The Private Placement Memorandum (PPM)
The PPM is the primary disclosure document. Each attorney has their own preference as to how it is written. Typically there will be five or six sections roughly broken down as follows:
- Introductory Summary
- A detailed description of the offering
- Summary of the Operating Agreement
- Sponsors’ biographies and backgrounds
- Risks
- Conflicts of interest
Introduction
This section will provide a brief overview of the offering. It will include an overview of the syndication’s structure and may provide an organizational chart. The plan for rehabilitation and stabilization of the property will be described.
Offer
A detailed description of the offering will declare the amount of capital being raised. It will explain how the funds are to be used. The sources of the funds will be reported with specifics as to the utilization.
The offering description will detail the distribution of proceeds. It will outline the different classes of investors and illustrate the proportional allocations and timing of distribution.
All the fees such as management, acquisition, and transactional will be declared. The proposed hold period will be communicated with provisions for early sale or extension. The restrictions on the transfer of interests or membership withdrawal will be explained.
Operating Agreement Summary
This section outlines the essential provisions of the Agreement. It identifies the managing partners, their roles, and the scope of their authority. An overview of voting rights is provided. Issues of management compensation, distributions, fees, transfers, and withdrawals are discussed. The chain of command, management replacement, and syndication dissolution are outlined.
Sponsors
This section will provide thorough biographies of each principal. It reveals their experience in business and real estate. Any security violations, criminal convictions, and bankruptcies will be declared.
Risk Factors
This is basically protection for the sponsors. It is like the fine print that we are all exposed to whenever we go to the internet and have to click “Yes I Agree to the Terms.” Though many of the risk factors are apparent, you should still read this section because some unexpected risks may be problematic for the investor.
Conflicts of interest
This section will always be present. The interests of two different parties will never align completely. Nevertheless, all known conflicts of interest need to be disclosed.
It could be the sponsor has a prior relationship with the largest investor. It will likely disclose that the sponsor intends to purchase other properties while holding the property under consideration.
The PPM is a legal document, but a non-legal marketing section is often included or added as an addendum.
Operating Agreement
The Operating Agreement is THE governing document for the whole organization. Almost all Operating Agreements will contain nine sections:
Definitions
- Throughout the Operating Agreement, there are capitalized terms they are defined in the definition section. Some capitalized terms are not in this section, and you may have to hunt for their definition.
- Definitions are essential because terminology does not always mean what we might think. It is critical to understand each defined term’s usage as it pertains to this document and operation.
Membership
- The various investor classes are outlined
- Membership admission is described
- How are transfers and withdrawals of membership accomplished/restricted
- What happens in the event of death and how interests are transferred to heirs
- Do sponsors have the right of first refusal if parts are transferred?
Meetings and Voting Rights
- What is voted on/what is not
- Who can vote
- Who can call meetings
Sponsors
- Rights and duties
- Authority to make decisions
- 3rd party right a single large investor may have control rights over major decisions such as in a Joint Venture
Management compensation:
- Fees for third parties
- How profits are distributed
- What happens to depreciation
Hold period
- How long is the expected hold
- Extension options
- Right to sell early
Accounting
- Who completes tax returns
- Who provides reports and how often
- How is the company to be disposed of with when all is closed out
- Spousal agreements
Capital calls
- Under what conditions – down economy to avoid foreclosure, renovations go over budget, or not enough money was raised to start with
- Are capital calls mandatory — if not, the sponsor can raise capital from other sources, which dilutes your investment interest – your % of ownership declines
- Are there penalties if you do not fulfill a capital call.
Subscription Agreement
The Subscription Agreement is your pledge that you subscribe to the provisions of the Operating Agreement. You are also agreeing that you will submit the capital at the time it is requested. It also declares to the sponsor that you have read and understand the PPM and Operating Agreement’s terms and conditions.
A confidential questionnaire is included in the Subscription Agreement. Here you’ll provide your personal information – name, address, social security number, how much you will invest, and how you want to receive the distribution. You may be asked if you are an accredited investor, and you will need to document.
The sponsor is not required to accept your Subscription. The offering may already be filled. It may be that the sponsor does not feel that the investment is appropriate for you. Whatever the reason, acceptance of the Subscription Agreement is at the discretion of the sponsor.
Things to keep in mind before becoming a passive investor
Non-liquid investment
A real estate passive investment is not liquid. A typical hold period for a value-add multi-family apartment syndication is about five years. The property may be disposed of sooner or later. The time frame of disposition depends on the management plan’s success or failure and prevailing market conditions. The proposed time frame stated in the acquisition documents will always come with flexibility.
There may or may not be provisions in the Operating Agreement that allow for the sale or transfer of the passive investor’s interests. Be sure to read this portion of the Operating Agreement carefully and understand your options. Life happens, and the future can never be predicted.
Passive real estate investing is an excellent avenue to financial freedom. As a non-liquid investment, passive real estate investments are not the place to invest emergency funds. Passive real estate investments are the perfect place for long-term hold investments.
Sources of Investment Funds
Retirement accounts are perfect for passive real estate investment funds. Unbeknownst to many people IRA, 401K, and Solo 401K accounts can be self-directed. As self-directed accounts, they can be used as passive real estate investments.
With knowledgeable guidance rolling-over, existing retirement accounts to self-directed accounts is an effortless process. For information on self-directed IRAs, tune into the Creek Side Chats podcast episode 32. Our guest, Kaaren Hall, is the CEO of uDirect IRA Services. uDirect is a self-directed custodian. They handle the self-directed process from start to finish.
For information about Solo 401K’s, tune in to Creek Side Chats episode 114.
Dmitriy Forminchenko is our guest. Dmitriy is the Sense Financial Services CEO, a boutique financial firm specializing in self-directed accounts with checkbook control.
For those who do not currently have IRA or 401K retirement accounts, Kaaren and Dmitriy will provide information and guidance on establishing and maintaining the accounts.
Home Equity
There is equity in the home for those who have owned a home for any length of time. Rather than letting that equity just sit there, take out a home equity loan. Invest the equity in a passive real estate investment.
In a syndication investment, the property will often be a rental property. Rental properties will provide cash flow, tax benefits, and residual income. If you leave the equity in your home, it will bring you none of these benefits.
Inheritance
Don’t spend the inheritance. Invest the estate, and it can bring long-term financial freedom.
Friends and family
For those who do not have funds of their own, educate yourself. With education, you can provide wealth-building opportunities for your friends and family members. Together you can all develop a path to financial freedom for everyone.
Life Insurance
Most life insurance policies carry a provision for borrowing from the plan. Our guests, Mark Willis, of Lake Growth Financial Service on Creek Side Chats episode 102, and Sarry Ibrahim, of Financial Asset Protection on episode 84 of the Creek Side Chats podcast, specialize in providing life insurance that actually pays you while you sleep. They offer specialized life insurance plans that, even as you borrow, continue paying interest on the policy’s total value. This can be an excellent source of passive real estate investment capital to build wealth.
Be creative
There is a way to find the money to invest. Open your mind to the possibilities and the solution will present.
How can you Generate Passive Income From Real Estate?
The excitement of a passive investment in real estate syndication beings after you make your first Subscription. Distribution may start as soon as 30 days after acquisition. This is not the norm. There are no surprises, though, as the distribution schedule is disclosed in the Operating Agreement.
Within thirty days, the passive investor will receive notification of closing. Typically this is just an official notice if there are no mishaps. Occasionally, there may have been some glitch in the closing process. If there was, it would be reported in this first report.
Benefits of Passive Real Estate Investing
The real joy will come when the distribution begins. In a passive real estate investment, the benefits extend well beyond the regular distribution. Passive investing in real estate syndications is often referred to as the IDEAL investment. The IDEAL is an acronym for Income, Depreciation, Equity, Appreciation, and Leverage. For a discussion of all five of these components, see the post, 5 Fiscal Reasons to Invest in Real Estate/Real Estate Investing Benefits.
What are the different ways of Investing in Real Estate as a Passive Investor?
We are bullish on passive real estate investing through real estate syndication. There are other strategies, though, to earn passive income through real estate investing.
Direct lending to active investors is a strategy that many passive investors employ. Another option, Real Estate Investment Trusts (REITs) are publicly traded through the stock exchange just like a stock. They are the most passive real estate investment strategy. A third popular passive investment strategy is investing in real estate discounted notes.
The post 12 Best Real Estate Investment Strategies for 2021 , provides a more thorough explanation of these strategies. These strategies are viable and can be lucrative. Nevertheless, of all of these strategies, investing in real estate syndication is the only strategy that provides all five of the IDEAL benefits that we mentioned before.
The mission of Steed Talker Capital is to create financial freedom for all our investors. Removing just one of the IDEAL benefits from the investment reduces the potential return on investment. The shortest route to financial freedom is found when we take advantage of all five IDEAL passive real estate investment benefits.
How to sustain as a Passive Investor?
Investing in one syndication is excellent. To sustain the investing momentum and develop financial freedom, continue to repeat the process. As the investor’s wealth grows, diversification is a must. Never leave all assets in one basket.
If the investor has $100,000, invest $25,000 in four different syndications. When that grows to $500,000, divide it up further. Invest in various sectors, not just other syndications.
For example, place $100,000 in $25,000 increments in four different syndications in the sector of multi-family apartments. Do the same with the sectors of mobile home parks, self-storage, retail/office, and industrial. This diversifies the investment across 20 different syndications and five different sectors.
Diversification is needed because all markets have cycles. With diversification in multiple syndications and across sectors, the investment will be sustained. When one sector flourishes, another may be facing stagnation. There is no such thing as a recession-proof investment. Diversification provides a safety net to preserve the capital assets through the various market cycles.
Conclusion
I hope you found the article beneficial. I’d like to hear from you. What is your investing experience, if any? Have you invested in real estate syndications? If you have, now was the investment experience? Drop me an email with your thoughts and questions: allen@steedtalker.com. If you’d rather talk, Schedule a FREE call.
About the Author — Dr. Allen Lomax.
With careers in academia, podcasting, and real estate investing, Dr. Allen Lomax inspires us to break open our minds’ secrets to success. Through passive real estate investments, he helps engaged professionals create time freedom to live abundantly in all life’s areas.