No doubt many (if not most) of you have seen the ads on TV or radio offered by any number of real estate gurus. They are advertising vast riches and wealth if you only buy their courses and get into real estate investing. A big part of that pitch is that real estate investing is something you can do in your spare time and that it is passive investing for the most part. The first part of the preceding sentence bears a lot of truth but the second part does not. The reason it gets thrown around so much is because it makes the pitch sound that much better, and thus easier to sell.
Before we go much further it bears exploring what passive investing actually is. From Merriem-Webster’s online dictionary: (4) passive investing means ” of, relating to, or being business activity in which the investor does not actively participate in the generation of income.“ What this essentially says it that unless you are giving your money to someone else to invest for you, you are not investing passively.
Let’s take a look at a couple different ‘investing’ categories and see just how passive they are:
Wholesaling: Not passive.
- You are going out, finding properties at a significant discount and selling that discount to another investor.
- The IRS taxes this as ordinary income depending on volume.
Flipping: Not passive.
- Similar to wholesaling, it involves the same level activity with the notable exception of improving the property at increased expense.
- The IRS also taxes this as ordinary income depending on volume and hold times.
Landlording: Depends on your point of view.
- Most of you reading this probably don’t have your money in a hedge fund or REIT that invests on your behalf. That is passive in our definition.
- The IRS normally taxes investment income from rentals as passive at long term capital gains rates as well.
- That said, if you are managing your own properties, you are not passively investing.
- Even if you have a property manager, you still have to manage them and are typically involved in day to day financial decisions, etc.
Certainly there are many more fields within real estate investing that we can explore. However, they are more complicated and usually require a level of experience and sophistication that does not come into play in this discussion. Additionally, the 3 areas we did touch on are the ones primarily discussed by gurus and teachers.
As you can see, 2 of the 3 are not passive and the third is more likely not passive in most cases. None of this is intended to discourage you from real estate investing. Rather, it is to help open your eyes in advance and keep you from giving your hard earned money to those who would purposefully mislead you.