12 Reasons Why Engineers Should Switch From Active Investing to Passive Investing

#1 – Headspace and Worry

I am a busy, full-time engineer working in the aerospace industry. One day last year while at work, I received a call from the rent court company I had hired for one of my single family houses. I was told my tenant failed to appear yet-again, and my case would be pushed yet-again to next month. We were entering the 5th consecutive month of failure to pay rent. ($7500 and counting...)

We were told the tenant had called the courthouse that morning, complaining that she was "sick" and the Baltimore, Maryland court system readily allowed this case to be pushed yet another month. This was after months of calls, email and text messages with the tenant, court clerks and lawyers.

All this time without being paid, and my mortgage payment was still due on the 1st of each month. The tenant was living in my property for free. The larger expense here was the amount of mental energy, headspace and worry that this took up during these months.

As a passive investor, you don't deal with any of this. Our assets have a professional asset team to manage the professional property management company to handle these issues. Professional all the way. I have invested into 8 passive investments (private placement -- syndications) and I have yet to receive a call regarding a tenant, legal, monetary or property issue.

#2 – Time (Up to Close)

Situations like the example above are not uncommon, but there are other areas of the business that can take up even more time. Finding a deal (or many deals if you are working within single family) requires hours of research to understand a market, underwriting to ensure the deal has a high chance of being profitable, working with the seller to come to an agreement on price, getting outbid, securing financing, etc.

Once I have vetted an operator (links at the end of the article on how to do so), the time it takes to invest into one of their deals is sub one hour. Personally, I always bet on the operators over the specific deal. The process typically goes -- fill out a form, schedule a call, join their distribution list, receive email updates as to when upcoming investment opportunities are, review the deal and the webinar, submit a commit, fill out the PPM (private placement memorandum), then wire the funds.

#3 – Time (Post Close)

When I first started purchasing single family rental homes, I thought getting a property manager would magically bring the amount of time I spent managing the asset down to zero, wishful thinking right?

After three years of owning multiple single family rentals at one time, I calculated that I was spending an average of 90 minutes per property per week. While this may not seem like a significant amount of time, thinking of the end in mind (specific goal of passive income each month) and the amount of properties that I would need to get there -- this would turn into another full-time job.

After a passive investment closes -- the only time that I spend is reading through the investment update each month (this takes sub three minutes after the first month or two) then allow the distributions to be directly deposited via ACH into my bank account.

#4 – Risk and Liability

With active investing, if (and when) things go south, you are personally held liable, which means you may lose not just the property but also your other assets.

With passive investing, your liability is limited to the capital you invest -- for example, if your investment is $50,000, your entire liability is the $50,000 that you have invested. Typically, the asset is held in an LLC or LP. If anything goes terribly wrong, the sponsors are held liable, not the passive investors.

#5 – Economies of Scale

When investing actively, you are likely limited to the amount of capital that you personally have to invest. For example, if you are purchasing single family houses and you have $50,000 to invest, you may be able to buy a house that is $250,000. When buying a single house, you are likely not receiving any type of discounts in regards to property management, materials, leasing etc.

Take the same $50,000 to invest into a passive deal, even though you may only own a fraction of the asset, you are achieving the scale of having many other investors invest along side you. For example, the leaky toilet that causes a plumber to have to drive and come on site when owning a property yourself may cost $200+. In a passive investment, due to having onsite management, this may take 10-15 minutes of a $20/hour employees time. When looking at property management, standard costs (from my experience) can be ~10% of gross rent collected + half of the first months rent to lease the property -- these costs can be anywhere from 2.5-4% in larger assets.

#6 – Valuation

Due to being an engineering math nerd and using spreadsheets every day, I have always loved things that were systematic and equation driven. Single family houses are neither, their value directly ties to the current state of the real estate market (comps) and future appreciation is based off of speculation.

When looking at passively investing in larger commercial assets (apartment buildings that are 5+ units), the value is based on a mathematical equation.

Value = (net operating income) / (cap rate).

To walk through an example: Say there is a 100 unit property that has a delta between current and market rents of $150/unit/month and there is an additional $50/unit/month of operational expenses that can be reduced, this would net out to a $200 net operating income difference/unit/month.

$200 per month x 12 months = $2,400 per year x 100 units = $240,000 per year of net operating income (NOI) uplift. Say the building trades at a 5 cap (this can be higher or lower depending on the exact asset), the $240,000 of NOI increase would be worth an additional $4.8M of increased property value. $200 per month can really go a long way here.

#7 – Diversification

With active investing, you yourself would need to be an expert in the market and asset class you’re investing in. This likely means that you may only be able to invest in one single asset class and one single area. While this can turn out great if the area performs well, this also puts all your eggs in one basket.

With passive investing, it’s easy to diversify across different markets, since you don’t have to start from scratch with each market. You are investing with teams that have already taken the time to research those markets and built strong local teams. Personally, I am invested into 8 different passive investments that are spread over eleven states, four different asset classes (multifamily, RV parks, self-storage, hotel funds), two different classes of multifamily apartments (B and C), and unit counts ranging from 12 to 212.

#8 – Risk

When actively investing into a single family rental, the property is either occupied or it is vacant -- there is no middle ground. If the property is occupied, there is likely cash flow, if the property is vacant, then it is bleeding money.

When investing passively into a 200 unit apartment complex, there are many different possible scenarios. On average the break even occupancy (percentage of units occupied to cover all expenses on the asset) is between 55-70% occupied. This means that anywhere from 60-90 units in the property can be vacant and the debt will be able to be paid.

#9 – Team

As an active real estate investor, you will need to build your own team, mine included people such as -- Brokers, Property Managers, GC's, Handymen, Accountants, Lenders and Inspectors etc.

As a passive investor, you rely on the shared expertise of the existing deal sponsor team. The sponsors are experts in the market and typically already have a team set up to manage the property. From my experience, many busy professionals don't have the bandwidth or desire to become a true expert in each area of real estate investing, they may like the asset class, but are inhibited from making this their full time focus.

#10– Capital Investments

Active real estate investors should plan to handle insurance claims, emergencies, and repairs, which may require additional money at times. Each month I had to set aside a portion of my cash flow to account for future expenses.

Over the last few years of passively investing into 8 different projects, I have only made the initial investment into each deal.

#11 – Back Office Paperwork and Taxes

Active investments are paperwork-heavy, from the initial purchase of the property to tracking purchase and rental agreements, bookkeeping, insurance and legal documents throughout the project. You’ll be responsible for the bookkeeping, meaning that you will need to keep track of the income and expenses. Additionally, you will have to count on your CPA to properly depreciate the property each year.

With passive real estate investments, on the other hand, you typically sign a single PPM (private placement memorandum) to invest in the property. No need to fill out lender paperwork, file for insurance, or do any bookkeeping. At the end of every year, you receive a Schedule K-1 for your taxes, which shows the income and losses for that property. Typically there are large K-1 deductions from syndications which can offset a portion of your active W2 income.

#12 – Scaling Your Portfolio

Single family rentals are resource intensive. Both money and time. Lots of them. Ask me how I know.

Passive investing in apartment syndication deals allows you to grow your portfolio much quicker. Even though you own a smaller fractional percentage of each deal, the returns are usually better. I went from owning a few single family doors to well over 200 doors in just a couple of years. My ROI on the single family rentals was in the mid-single digits whereas my syndication deals have consistently tripled or quadrupled that figure.

As an engineer, I call that working smarter, not harder.

Want to Invest Passively?

If you are interested in learning more about passively investing in real estate, you can sign up to learn about upcoming opportunities here or schedule a call here.

Learn how to vet operators here.

About the Author

Stephen Predmore is the founder and Principal of Talbott Investments, a real estate investment firm that offers passive?investing?opportunities to limited partners through partnerships & syndications. Talbott Investments has invested in over 200 multifamily apartment units and over 200 self-storage units with a combined value exceeding $25 million. Stephen's main responsibilities include oversight on acquisitions, sourcing investor capital, investor?relations and building partnerships?with top tier operators.

Prior to escaping the snow at the University of Buffalo, he completed his Bachelor of Science in Mechanical Engineering with a minor in Mathematics. Currently, Stephen lives in Baltimore, Maryland, with his wife, 2 kids and a labradoodle.

To learn more, check out our website.