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Owning a rental property can be a great investment.
Especially if the neighborhood you buy in is growing fast, there’s lots of demand and not a lot of supply, and your tenant also happens to be a nun.
But that’s almost never the case. In fact, I’ve heard, and seen, some horror stories.
Drug dealing tenants, mice, bed bugs, holes through drywall, backed-up toilets…you name it.
I’m telling you this not to try and scare you away but to make you aware. I also know a lot of people who have had great success investing in rental properties, both commercial and residential, without too many headaches.
Their days are envious. A few phone calls to their property manager in the morning, troubleshooting any issues that come up in the afternoon, and cheques arrive in the mail or through direct deposit the first of every month. Not a bad gig.
As far as investments go, real estate has a lot going for it. It’s a hard asset, meaning you can reach out and touch it. It’s relatively stable — regardless of the economy, people still need a place to call home.
And, having tenants that pay you rent every month, qualifies you for some decent tax breaks. But should you buy a rental property and become a landlord or is it smarter to invest passively in real estate?
First, What’s the Difference?
The main difference between becoming a landlord and passively investing in real estate is the time commitment.
When you buy a rental property and become a landlord, you’re essentially signing up for a second job. At a moment’s notice, you might have to drop what you’re doing and worry about things like:
- Lost keys in the middle of the night
- Noise complaints
- Backed-up toilets
- Bed bugs
- Property taxes
- Property depreciation
- Drugs
- Tenants that don’t pay their rent
- Mice and other rodents
- Unreliable property managers
- Broken appliances
- Broken windows
However, the upside is you could own a property that only requires minimal maintenance, with a tenant that’s respectful and pays their rent on time. While your mortgage is being paid off, you’re building equity until you finally decide to sell or buy another property.
Or, your house might be paid off already and you decide to rent a room or separate floor — that creates another stream of income you can use to help fund things like your next vacation, a new car, or boost your retirement savings.
But becoming a landlord is not the only way to invest in real estate. There are lots of passive investment opportunities in real estate that don’t come with as many hassles.
The most popular is publicly-traded real estate investment trusts (REITs). These funds are professionally managed and typically consist of many different properties pooled together.
You can also look into directly investing in one real estate project at a time by buying shares of debt or equity, or both.
A History Lesson on Crowdfunding
In 2012, Obama signed the JOBS Act to encourage funding of small businesses in the U.S. by easing securities regulations.
What drew the most attention from the bill was Title III, also known as the CROWDFUND Act, because it created a way for companies to use crowdfunding to issue securities.
All to say, it created the opportunity for online platforms to develop where individual investors could pool their money together and directly invest in things they might not have been able to before, like real estate.
Here’s what it could look like:
A developer is trying to drum up $10 million in financing to renovate a 30-unit apartment building. What typically happens is the developer will tap his friends, family, and network to invest.
But he needs a bigger investor base if he’s going to reach his goal. So, he decides to sell securities (debt or equity) as an investment opportunity to any individual accredited investors.
If all goes to plan, then it’s a win-win for the developer and the investors. Without the financing support, the project might not have gone ahead. But with the pooled investment dollars, the reno moves forward and now the investors have the opportunity to earn passive income from the rental property. All without having to become a landlord.
Not All Deals Work Like This
This isn’t always the case though. Sometimes you invest in projects and they go bust. Like any investment, real estate carries it’s fair share of risk with no guarantees.
But, as long as you’re aware of the risks going into a project, you can decide how much you’re willing to invest.
It’s also important to note that not all real estate investing platforms are created equal. Some are exclusive to commercial real estate, whereas others focus on residential. And, you typically choose to invest in either debt, equity, or both.
Lastly, some platforms are marketplaces where anyone can sell — be careful in these. While other platforms, only vetted and underwritten opportunities get listed.
The Question: Should You Become a Landlord?
If a friend asked me this question today, I would ask them a few follow-ups:
- Do you have time to manage another property?
- How familiar are you with the neighborhood?
- What’s the supply and demand like where you’re looking?
- What would you do if property taxes changed? Could you still afford it?
- Are you willing to take phone calls in the middle of the night?
- Do you have enough savings to go to court if you have a bad tenant?
- Will you hire a property manager or DIY?
These questions aren’t to deter my friend from investing or becoming a landlord. They’re important to ask because you need to consider all your options if the worst case scenario were to happen.
Passively investing in real estate is no better than physically managing properties yourself. But they both come with pros and cons. If you love doing renovations and keeping busy, then becoming a landlord might be a nice second career.
If you’re strapped for time or money, but still want to invest in real estate then crowdfund opportunities could be the right play. There’s no definitive right or wrong answer here. It’s also worth considering the type of returns your investment could make elsewhere too.
To a richer life,
Nilus Mattive
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