As an asset class, real estate can offer investors long-term stability, regular cash flow from rents, appreciation gains, and a basket of unparalleled tax advantages. Within the real estate space, there are two ways to generate returns via commercial properties- active vs passive real estate investing.
Active real estate investing involves taking control of the process of acquiring, financing, purchasing, and operating income-generating real estate properties. Passive real estate investing encompasses a wide range of passive investments, like REITs, real estate company stocks, real estate funds, and other forms of indirect investing where your only responsibility is providing capital and collecting returns.
Let's take a look at the pros and cons of both active and passive commercial real estate investing.
Active Real Estate Investing
Should you decide to travel down the path of an active real estate investor, you will need to wear many hats. Being actively involved in real estate deals requires foundational knowledge of, and ideally a mastery of many skills, including:
Finding Investment Properties
Active investors are responsible for finding and vetting commercial real estate investment opportunities. Agents and brokers can help in the search, but they do not work for free- active investors can expect to pay a percentage or flat fee for the property lead. This means active real estate investors end up spending a fair amount of their time searching online databases like LoopNet and other local property listings, and connecting with buyers, sellers, and real estate professionals.
When acquiring commercial investment properties, the investor is responsible for undertaking due diligence, for both the physical condition of the property and the underlying business. In the residential market, it is much easier to determine the value of a piece of property- find comparable property sales data, and you can guesstimate the market value.
With commercial properties, it is much harder to accurately determine the value of the building, underlying property, and the financial operations of the subject property. Properties are often significantly more complex than residential units and may include kitchens, advanced heating and cooling systems, manufacturing equipment, and other items that are utilized by commercial building tenants.
These are complex transactions, and there are many opportunities to lose time and money with needless delays. Before performing due diligence on a commercial real estate acquisition, it helps to have a strong team behind you- appraisers, agents, brokers, attorneys, title reps, and others.
Financing is an integral facet of active real estate investing. Even if an investor has deep enough pockets to finance a development or purchase on their own, with interest rates being as low as they are, it makes much more sense to finance acquisitions through lenders if possible. There are many different ways to raise capital for commercial real estate investments, including traditional lenders, hard money and bridge lenders, and crowdfunding platforms, among others.
After obtaining a commercial property or portfolio, active investors need to manage the property. There are commercial property management firms, but their fees tend to cut into expected ROI pretty substantially, especially over the long-term. Without the help of a property management team, investors can expect to deal with tenants, market the property, oversee day to day maintenance and renovation projects, maintain business financials, and whatever other tasks need to be taken care of in the natural course of running a commercial property.
Passive Real Estate Investing
For passive real estate, investors leave the heavy lifting to professional investment advisors and wealth managers, who are compensated via performance or through an agreed-upon flat fee. Real estate investment managers often combine funds from a large group of investors to acquire larger and more profitable properties than any one investor would be able to purchase alone. Managers are responsible for pooling funds, business plan execution, running day to day operations, and providing financial statements to investors. Investment firms often have access to the non-recourse debt market, which helps reduce risk and volatility.
Here are a few of the investment vehicles passive real estate investors use to generate returns:
REITs, or real estate investment trusts, operate in a similar manner to mutual funds. Individual investors pool their capital to purchase a share in a commercial property or portfolio and earn income from the property's cash flow and appreciation. There are three main types of REITs, equity, mortgage, and hybrid. Equity REITs acquire and manage hard real estate assets, mortgage REITs work in the commercial and residential mortgage space, and hybrid REITs are a combination of both equity and mortgage REITs.
Real Estate Funds
Real Estate funds offer many of the same benefits as mutual funds, but with additional professional management. Real Estate funds both invest in property directly and invest in REITs indirectly. Commercial and corporate properties dominate this space, but there are real estate funds that speculate on land, undertake agricultural or resource investments, and developed mixed-use and multifamily properties. Real estate funds generally create gains through property appreciation and do not typically provide the steady, short-term cash flow that REITs provide.
Real Estate Company Stocks
There are many real estate service providers and related companies that are listed as equities on the stock market. Companies like Brookfield Property Partners L.P. (BPY) and Colliers International Group Inc. (CIGI) either work in property management services, sales and purchases, development, or one of the many other facets of the real estate business. Investors can gain exposure to a particular region or market, as well as in real estate adjacent businesses like Zillow or Redfin.
There are circumstances where active real estate investment is ideal, and situations where passive investing makes more sense. Many accredited investors possess the capital requirements and ability to succeed in the direct/active investment field, but not the time. For those who have the time, drive, and background knowledge to succeed- active investing may generate excellent returns. Investors who may not have as much time on their hands, but still want to enjoy the myriad benefits of real estate investments may see passive investing as ideal.