Direct real estate ownership vs passive investing: What strategy works better?

Direct real estate ownership vs passive investing: What strategy works better?

March 12, 2024

When investors look at commercial real estate, they often weigh the option of acquiring a real estate asset or investing passively. These two strategies each have their own set of advantages and considerations. In this article we will examine both the pros and cons of direct real estate ownership and passive investing approaches.

Where to begin with direct real estate ownership

Direct ownership of a property means the investor is acting alone, or with a select number of partners, and therefore has a high level of control and responsibility throughout the process. This runs the gamut from initial research of the property and the market, to negotiation and purchase, to the day-to-day management of the property. 

Let’s examine what’s involved in this process.


1. High acquisition costs and extensive diligence processes

Initial research is critical to the success of any investment, and investors who are also in the position of landlords must dedicate substantial time in analyzing the market, studying the performance of the specific asset type, and shopping for a mortgage. Once an investor decides to purchase an asset, they should expect upfront costs beyond the purchase price, including closing, broker, mortgage, and legal fees, taxes and insurance premiums. Investors must exercise financial acumen to ensure they have sufficient capital for any maintenance, renovation, or unexpected costs involved in the property at a later date, as well as reserves for paying interest on the mortgage if there is one. 


2. Finding the right tenants 

Successful real estate investment hinges on effective tenant acquisition to ensure income generation. Marketing strategies can include online listings, social media, hiring a brokerage firm, professional staging and photography, and competitive pricing based on market research. Screening and ultimately selecting the right tenants is vital to avoid any potential pitfalls, and maintaining good long term relationships is key.


3. Taking on liabilities and risks 

When investing directly in real estate, investors may sometimes assume a level of personal financial liability if they take on a mortgage. Risks can include fluctuations in the market, or economic downturns, which could lead to increased debt payments on variable loans that may impact cash flow, or cause elongated vacancy periods. Additionally, direct owners are responsible for ensuring their properties comply with all local laws and regulations.


4. Maintaining the property 

In order to preserve value and retain quality tenants, owners should consider regular inspections, cleaning, landscaping, and system upkeep. Maintenance also involves addressing wear and tear and making necessary repairs and replacements promptly to avoid more significant issues down the line. 


5. Factor in ongoing expenses  

Beyond acquisition and marketing, real estate ownership comes with ongoing expenses. These can include variable costs such as property taxes, insurance and utility bills (if not covered by tenants). Real estate taxes can also potentially impact an investor’s ROI. Further, turnover costs can often exceed expectations, as transitioning units need to be cleaned, repaired, and advertised in order to quickly find tenants and not lose out on rental income.


6. Higher risk, higher potential reward

When carried out successfully, direct owners benefit from a bigger portion of the pie and the potential for more lucrative returns to the investor than in passive investing. Investors also have the advantage of  greater flexibility since they can sell or refinance the property based on their own timeline.


Now let’s look at the option of passive investing in real estate

Passive investing allows individuals to contribute capital to a real estate investment company (typically structured as a SPV) and participate in real estate ventures without needing to be actively involved in managing the properties. Passive investors can benefit from the knowledge and data-driven systematic processes utilized by experienced real estate professionals. 

Let’s examine the process from the passive investment perspective.


1. Predetermined capital contribution  

Passive real estate investing significantly reduces an investor’s direct costs, providing an accessible pathway for individuals looking to enter the market. Investors’ principal is contributed upfront, without additional out of pocket expenses throughout the investment lifecycle. This streamlined model simplifies the investment process, with no surprises, making it easier and often more affordable to get started. 


2. Risk mitigation

Investors who choose passive investments rely on the expertise of real estate professionals  to structure deals that have been pre-vetted, in markets chosen for their strong fundamentals, backed by financial analysis. By leveraging this know-how and experience, passive investors can benefit from risk mitigation they may not otherwise have access to. While there are still costs associated with running the property, these are built into the structure of the investment, and any unexpected fluctuations are reflected in the returns, rather than an additional expense for the investor. 


3. Expert property management

The management of the underlying assets, including tenant acquisition and relations, is conducted on site by property managers. This removes the challenge of marketing from the investor and simplifies the ownership process. Maintenance of the properties in passive investing is also the responsibility of the property manager, not the individual investor. As such, investors don’t have to deal with property upkeep, emergency repairs, or routine maintenance issues. This is a significant benefit for those who want exposure to real estate investments without the complexities of being a landlord. 


4. No liability to investors

Passive real estate investing provides a notable advantage as the structure of the investment vehicle helps to limit individual liability and investors’ risk exposure is confined to the capital they have contributed.


5. Conservative underwriting

While passive real estate investments can offer potential upside, targeted returns are typically more conservative than those from owning property outright. Given the pooling of risks and rewards among all investors, passive investments offer a relatively hands-off approach to achieving diversification and generating income from real estate, with more limited risks to limited partners.


To sum up, investors are presented with a choice when it comes to commercial real estate, and each strategy comes with its own set of pros and cons to weigh up. 

Direct ownership involves a high level of control, with a higher risk, higher reward approach that can entail substantial upfront costs, the possibility of continued expenses, as well as liability, tenant acquisition, and ongoing maintenance responsibilities.

Passive investing, meanwhile, offers a streamlined approach, where investors contribute capital without active management involvement. This strategy relieves the investors of the complexities and potential unplanned events that come with direct ownership, and provides an accessible pathway to real estate exposure with the benefit of risk mitigation.


iintoo continues to seek attractive opportunities for our investors, by leveraging existing relationships with sponsors and institutions to source deals, utilizing our dedicated team of real estate experts and financial analysts. Hundreds of opportunities are vetted each year, and our uncompromising requirements result in fewer than 1% of these deals being approved.  Read more about our approach in our company brief or log in to our platform to see detailed information on our current offerings.