Choose Your Path in Real Estate Investing

August 15, 2023

Diversify your portfolio with real assets

Before delving into any investment, many factors should be considered: your goals, time horizon, liquidity preferences, and risk tolerance, among others. However, this article will hone in on a critical yet often overlooked decision – the choice between passive and active strategies. Many individuals begin by purchasing single-family houses, unaware that alternatives exist. Below, I rank key strategies from the most active (requiring the most effort) to the most passive (requiring the least effort).

Active Strategies: Welcome to Your New Job!

Flipping: This approach, as depicted in reality shows, can indeed yield substantial profits. However, it’s more akin to running a business than making an investment. If you’re considering flipping, be prepared to dedicate significant time. Also, keep in mind that initial failures are common, often due to underestimating renovation costs, hiring subpar contractors, or overestimating resale values. Another factor to consider is the tax implications – profits from sales within a year are subject to income tax rather than capital gains tax. Flipping is not tax-friendly.
Short-Term Rentals (Self-Managed): Similar to flipping, this approach can be highly lucrative with the right property and effective marketing. Yet, be ready to embrace the role of a hospitality professional. Managing bookings, responding to customers, and coordinating turnovers demand substantial effort. While streamlining operations through systems and virtual assistants is possible, many find themselves deeply involved in day-to-day management.

Tweeners: Somewhat Passive but Not Entirely

Short-Term Rentals (With a Property Manager): To reduce the demands of managing short-term rentals, enlisting a third-party property manager is a smart move. However, this convenience comes at a price – management fees ranging from 20% to 50% of your revenue can significantly erode profits. While you can succeed with the right property, occupancy rate, and management team, this combination can be hard to find.
Long-Term Single-Family Rentals (With or Without Property Manager): Self-managing long-term rentals is simpler than handling short-term properties, but responsibilities such as tenant communication, screening, and overseeing repairs persist. While third-party management costs around 8-10% of rent, making it a preferable option, a few caveats should be noted: a) Replacing the income from your W-2 job with rental income requires a sizable property portfolio, b) As you accumulate properties, the workload escalates, and c) Today’s high interest rates make it difficult to generate positive cash-flow. While long-term rentals offer appreciation potential, alternative strategies might be more effective for scaling while preserving leisure time.

Passive Strategies: Enjoy Mailbox Money

Property Syndications: As explained in this article, syndications involve pooling resources with other investors to acquire larger properties like apartment buildings. The deal sponsor handles property management, and investors receive quarterly dividends and a substantial payout upon property sale (assuming all goes well) several years later. However, as I discuss here, you do need to carefully assess both the deal and the sponsor at the front end of the investment. So, it’s not 100% passive in that sense. Returns tend to be higher than single family unless you happen to strike gold in an appreciation wave like the last few years. But, note that syndications are not liquid investments.
Private Funds & Private REITs: Analogous to mutual funds, these options involve investing in a fund manager’s carefully outlined strategy. The big difference between syndications is you’re investing in a portfolio versus a single property. You’re betting that the fund managers will allocate capital well, be able to navigate interest rate changes, find attractive deals, etc. With syndications you can cherry-pick the deal and evaluate the property along with the manager. You get more diversification with funds but less control than you get with syndications.
Public REITs: Similar to private REITs but these are publicly-traded and provide liquidity akin to stocks. While they require less capital to initiate than private options, volatility mirrors that of public equities. The ongoing debate between private fund superiority and REIT performance rages on, with some asserting that recent market turbulence has undervalued public REITs.

My Approach: Shedding Single-Family Rentals, Embracing Short-Term Rentals & Syndications

Personally, I’m divesting most of my single-family rentals due to the intensive effort required and diminished returns due to appreciation, discussed here. Instead, I’m focusing on short-term rentals and syndications. Short-term rentals appeal to me for their high returns, though finding properties with excellent returns after management costs is challenging. Hence, syndications are my primary strategy.

When I invest, I am weighing return potential, passivity, scalability, control, and liquidity. Syndications give me four out of the five. I’m leery of private funds and public REITs because I don’t have a say in what they buy. I like to cherry-pick the best deals. The open-ended nature of funds / REITs doesn’t let me do that. I give up liquidity though, so I have to balance the rest of my portfolio and financial strategy to ensure I have access to capital if I need it.

In Conclusion: Crafting Your Strategy

Ultimately, the path you choose hinges on your priorities and the sacrifices you’re willing to make. Two things I am certain about: Most investors are under-allocated in real estate within their portfolio (not including their primary home, which is not an investment). The risk-adjusted returns from real estate outperform other asset classes, in my opinion. And second, real estate investors have more options than they think they do. Most investors (including me) thought buying houses was the only way to go. It isn’t.