Passive vs. Active Investing in Real Estate: Rentals vs Syndications (2024)

Chocolate or caramel? Rock or hip hop? Passive or active investing in real estate?

Some investors love buying rental properties directly and owning them in their entirety. Others prefer buying fractional ownership in real estate, through group real estate syndications.

We can’t tell you which one is “better” because both come with pros and cons. But we can break down those upsides and downsides for you, so you can decide whether passive versus active investing is better for you.

Pros & Cons of All Real Estate Investments

Before we compare active versus passive real estate investing, you should understand the advantages — and drawbacks — that most real estate investments share.

Real estate investments typically offer strong cash flow, long-term appreciation, and a fantastic hedge against inflation. In fact, one study across 16 countries over 145 years found that real estate generated better returns than stocks, bonds, or any other type of investment.

It also provides outstanding tax advantages, including property depreciation and dozens of real estate tax deductions. Plus, you have several options to defer or avoid capital gains tax on real estate.

For all those upsides, real estate investing has some cons as well. To begin with, it’s notoriously illiquid: it’s time-consuming and expensive both to buy and to sell. Compare that to stock investing, where you can click a button to buy or sell instantly, for free. That makes real estate an inherently long-term investment.

Real estate also costs a lot of money, which means you need plenty of benjamins to invest. Not everyone has tens of thousands of dollars snoozing in a savings account. While there are ways to invest $1,000 in real estate (or less), those options mark the exception, not the rule.

Finally, there’s a tradeoff between control and convenience in real estate investing. This lies at the heart of what we’ll explore today: how to decide whether to be a hands-on investor or a passive investor who just writes a check and calls it a day.

Active vs. Passive Investing: Pros of Rental Properties

Buying rental properties directly comes with plenty of perks. Consider the following upsides as you decide how you want to invest in real estate.

Control

When you buy properties by yourself, you’re in the driver’s seat.

You decide exactly what property you want to buy and for how much. You decide whether to renovate it, and if so, the quality (and expense) of those property upgrades.

Once the property is ready for a renter, you can screen the rental applications yourself or hire a property manager. You draft and sign the lease agreement, oversee rent collection, renew or non-renew lease agreements, and raise rents as you see fit.

Or perhaps you’d rather operate the property as a short-term vacation rental? That’s fine, too.

It’s your show; you make all investment decisions.

Choice of Exit Strategies

The hold time and exit strategy are entirely up to you as well. Do you want to refinance it following the BRRRR strategy, and potentially earn infinite returns? You may be able to pull your initial investment back out of the property, leaving you with no money tied up in it. Then, you simply hold it indefinitely, earning cash flow and letting the property appreciate even as your tenants pay down your rental property mortgage.

In fact, you could let the renters pay off the mortgage entirely, only to take out another mortgage to cash out the property without having to sell it. You also avoid paying capital gains taxes that way, even as you pull out your equity.

And, of course, you can sell the property whenever you like.

Easier Control Over 1031 Exchanges

Speaking of exit strategies, ambitious investors often like to 1031 exchange their rental properties when they sell, trading up to a larger property that generates more cash flow. That defers their capital gains tax on the sold property.

As an active investor, you control the timing of both the sale of the existing property and the purchase of the new one. While not “easy” per se, you still control both transactions. You can even pull off maneuvers such as reverse 1031 exchanges to make the timing fit your needs.

While it’s possible to use a 1031 exchange for real estate syndications, it’s harder. In most cases, you have to find a deal specifically designed for a 1031 exchange — and there just aren’t that many of those out there.

Losses Offset (Some) Active Income

Nearly all of the tax advantages of rental properties and real estate syndications are identical. But there’s one exception.

To explain it, you should first understand that as a general rule, losses on passive investments (such as stocks and real estate syndications) can only offset passive income and gains on your tax return. For example, if you show a $5,000 loss on a real estate syndication, it can only offset other passive income streams, such as other real estate income or dividends from stocks. You can’t use it to offset your salary or other active income.

Active landlords get an exception, however: they can offset up to $25,000 in active income each year with rental property losses. So if you show a $5,000 loss on a rental property, you can knock $5,000 off your W2 taxable income.

Disadvantages of Investment Properties

That greater control is all well and good, but it comes at a cost. Several, in fact.

High Cost to Buy

Individual properties are expensive, and when you buy them by yourself, you shoulder that cost alone.

Sure, you can borrow a rental property mortgage. But you’ll almost certainly put down 20–40% of the purchase price, which still typically means tens of thousands of dollars.

And that says nothing of closing costs and cash reserves. You’ll need both available for closing on the property, adding many more thousands to your bottom line.

Labor to Find Deals

A fellow real estate investor once told me “There’s no ‘deal tree’ where you walk up and pluck off deals any time you like. You have to go out and find them.”

Sure, you can go on the MLS or an investment property platform like Roofstock to browse available properties. But you won’t find outstanding deals — by definition you’ll pay market value on these properties available on the open market.

Alternatively, you can network with real estate wholesalers such as Norada or Asset Column. You’ll find better deals than on MLS, in many cases. But don’t expect earth-shattering returns.

If you want the best deals, you have to go out and create them yourself. You could find these off-market deals by driving for dollars, or through finding pre-foreclosures, or other distressed sellers.

And it all takes work on your part. Often, you have to reach out to a hundred sellers in order to close on one property. Think direct mail campaigns, phone calls with sellers, contract negotiations, touring properties, and vetting deals in general. Which says nothing of the work to line up financing.

It’s a lot.