The Definitive Beginners Guide to Passive Income in Multifamily Real Estate
“Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.” – Warren Buffet
I like this quote from the Oracle of Omaha. It speaks to our present situation with COVID-19 and the questions many investors continue to ask. If you have weathered the market downturn and are preparing to invest, now is the time to get into the real estate market. My recommendation: passive investing in multifamily real estate.
Part of my success in real estate has been through passive investing in multifamily real estate properties. This may be the first time you’ve heard of either of those terms: passive investing and multifamily. If so, this is the article for you. If you are ready for 10 steps to get started, head over to my article Passive Investing in Multifamily Real Estate Right Now.
Below you find an introduction to what I think is a powerful and lucrative way to invest in real estate. Why? Maximum returns for minimal effort. Read on to learn more.
What is Passive Income?
In short, passive income is an income stream that is somewhat hands-off or relatively automated. An investor makes an upfront investment of capital and receives a claim to a portion of the returns.
As an investor, your job is to invest in a property that will generate returns over the life of the investment with limited work on your part.
What is Passive Investing?
That ‘limited work on your part’ is key to the idea of passive investing. As a passive investor, you aren’t involved in the day-to-day management of the property. In the case of multifamily real estate, this means that an investor, syndicate, or property management company directly manages the property, while you as the investor reap the returns.
For those interested, the IRS uses the term material participation, which defines whether or not an investor is involved in the day-to-day management of an investment (property).
Passive Income – How You Make Money
As a passive investor in multifamily real estate, you’ll have access to three different ways to make money. The acronym I use to help beginners remember this is PAT, which stands for:
- Periodic cash flow distributions
- Appreciation and post-sale returns
- Tax benefits
Periodic cash flow distributions are the bread-and-butter of a passive strategy. After investing in a real estate deal, you’ll receive monthly, quarterly, or yearly distributions from the property. You can think of this much like a stock dividend. The important part of investing in multifamily properties is that the tenants of, say an apartment building, are paying rent, and this is part of the cash flow a property generates. Properties are usually improved by investors to generate more returns. Investing in apartment buildings can be a good way to make solid real estate passive income.
Beyond cash flow, you also have access to appreciation and tax benefits. Depending on your investment objectives, you may prefer a larger payout via appreciation over periodic cash flow distributions. Your investment needs will determine which way you will lean. Now, I could say a lot regarding the tax benefits of multifamily real estate investing. You can find more in my recent article on tax advantages and strategies here.
There are many different ways to invest passively in multifamily real estate. You can think of these as the different ways to find, access, and invest in deals. There are countless deal types and ways to get involved investing in multifamily properties. Understanding who hosts deals and what to expect is important. Here are the four ways to get involved:
- Private Equity
- Real Estate Investment Trusts (REITs)
- Crowdfunding (syndicates or private equity)
A syndicate is a group of investors who get together to invest in a property. Syndicates have been the primary vehicles for investing in real estate, especially as some properties can range well into the 10s or 100s or millions of dollars with many investors. A syndicate is led by a sponsor. The sponsor’s job is to find the property, create the investment deal, attract financing, acquire the property, and is responsible for the day-to-day management of the property. As the deal lead, sponsors get access to additional returns, often known as ‘sweat equity’.
Syndicates come in three primary forms depending on many factors: the deal size, number of investors, property requirements, tax considerations, etc. Below are the three forms:
- Limited partnerships
- Limited liability corporations
Syndicate sponsors get access to a property acquisition fee, often around 1% of the cash investment. They also get property management fees. Investors receive preferred returns.
Now, this is somewhat different than a syndicate. Much like private equity in the corporate world, an investor buys into the private equity firm. This is different than a syndicate, which is created around a specific deal: a pre-selected property. In the case of private equity, the firm is tasked with generating returns for investors, and will seek out properties as it sees fit. Private equity can be a lucrative route if you prefer to trust the expertise of investors in finding and selecting a portfolio of deals. They are most often available to accredited investors, those classified as high-net-worth individuals.
Real Estate Investment Trusts (REITs)
A REIT is similar to private equity and syndicates in that investors pool money that is invested in a property. However, there is an important distinction. A REIT is an investment company that investors purchase shares in. These shares can be bought, traded and sold, and are considered somewhat liquid. For investors looking for both a passive investment and something close to a stock, a REIT is a good choice.
I’ve included crowdfunding as it is a relatively new addition to the real estate investing market. In the past, syndicates and other real estate investing professionals couldn’t advertise investments openly. That changed in 2013, and now many syndicates, REITS, and private equity firms advertise online. To facilitate this, online marketplaces have sprung up that help connect investors with properties, and that function as sponsors themselves. Crowdfunding often has the added benefit of providing many options for first-time investors looking to get minimal exposure to passive investing in real estate. These websites list many different properties, including multifamily properties.
Last But Not Least: Pros and Cons
So far, we’ve covered the basics of real estate passive income, passive investing, and how to invest. In this last part, I want to review some of the pros and cons of passive investing in multifamily real estate.
- Invest in many different properties depending on your investment goals
- No day-to-day management
- Skip the tenants, toilets, and trash problems
- Don’t need to deal with banks
- Don’t need to understand rental property management
- Leverage the expertise and experience of others
- Make money with limited effort
- Limited liability
- No control over the property
- May be difficult to find the right deal for you
- Some deals may require large buy-ins
- Requires a great deal of effort upfront
- Investments are illiquid
As always, you can reach out to me any at time with questions or for help on how to begin your passive investing journey. Contact me at (630) 229-2383 or click here to connect with me online.