Passive Investing by the Numbers
What to expect:
A roadmap for building a passive income machine through real estate investing.
SEC definitions of accredited and sophisticated investors.
Networking with operators in real estate meetups.
Finding operators, building relationships, and analyzing financials before investing in real estate group investment opportunities.
The importance of understanding where returns are coming from in the investment opportunity and how the operator makes decisions.
What investment style is best for you?
Hey friend! This week, I want to ask you what you think is right for you: active or passive investing? You need to decide your time, money and risk resources, as well as your return, goals and timeline. For those who have little money but are willing to spend time and risk to gain returns on a shorter timeline, active investing might be the best option. For those of you who have busy schedules and don't want to get a PhD in real estate, passive investing might be a better option.
Crunching some numbers
You can start passively investing in real estate with as little as $25,000 which may not seem like a small amount, but consistently investing $25,000 Every year can lead you to replacing your income in maybe 15 years. Let me break down some numbers for you. If you invest $25,000 every year for 15 years, and reinvest the returns from your investment, which could be about 30,000 per year starting in five years, then you're investing $25,000 a year for the first five years and $55,000 a year for another 10 years. So within those 15 years, you will have invested $705,000 into real estate, assuming an average return of 8%. Your passive income will be around $56,400 Every year, which is generally taxed at a lower rate than active income as well. So by investing $25,000, every year while you're working, you can create a machine that works for you. If you continue putting in another 25,000 every year until you have about a million dollars total invested, you can increase that passive income number to $80,000 per year, assuming an 8% return on investment. Another thing is that you can also accelerate this number and get to $80,000 plus per year faster if you increase your time in the market, meaning the sooner you get started and the more you invest, the faster your passive income machine can be built.
How to start passively investing
So how do you get started in passive investing? First, you have to identify if you are an accredited or sophisticated investor. What is an accredited investor? This term is a legal definition used by the SEC (Securities and Exchange Commission) that refers to individuals or investors who are essentially rich enough to not need protection. Protecting investors is the main job of the SEC- they impose regulations that make it difficult for public and private parties to take advantage of investors. Unfortunately, this also means that it can limit certain investments and limit the people that can get into certain investments based on their definition of “rich enough not to need their protection”. In this case “rich” means your annual income is $200,000 individually or $300,000 with a partner, or you have a net worth of more than one million individually or with your spouse excluding your primary residence, meaning the house you live in. So, if you are an accredited investor, you can get access to certain investment opportunities, such as private placements, private group investments, or private equity and more.
What is a sophisticated investor?
So then does that mean if you aren't rich according to the SEC, that you can't invest passively at all? Absolutely not. By the SEC standards, you are a sophisticated investor. A sophisticated investor is someone who has enough money, experience and net worth to participate in more advanced investment opportunities. If you are a sophisticated investor, you are smart enough to know how money and financial markets work. Sophisticated investors also have enough knowledge and experience in financial and business matters to make them capable of analyzing the pros and cons and risks of a potential investment. So how do you invest if you are a sophisticated investor? You know that saying “it's not what you know, but who you know”? In this case, it's a bit of both. You need to know about money, but you also need to know operators. These are the people who put together the deals for people to invest in. You need to know how to vet an operator as well as their investment opportunity, and you need to know how to find operators. So how do you find these operators, and how do you vet them?
Finding & Vetting Operators
The first step is to go to your local real estate meetups. A lot of us operators hang out there, and we're very open to meeting you and educating you. If an operator isn't interested in educating you, that's a red flag. You want to work with an operator who's happy to give you that PhD in real estate, using all of their own knowledge and resources. You want to be able to build a relationship with an operator. And if an operator tries to sell you their deal before getting to know you really well, that is also a red flag and illegal. They should be asking you about your investment criteria, expected returns, risk tolerance and more. If they tell you their deal is for everyone, that can also be a red flag. Every investment offering has a different structure. They're based on different balances of cash flow, equity, and depreciation. They also have different timelines and metrics for measuring success. They're all based on different underlying assets as well, meaning they're all using different things to make money. So you need to be asking operators about all of these things. And if you forget to ask them, they should be telling you.
So to recap:
Step one: go to real estate meetups and find the operators.
Step two: build relationships with them and ask lots of questions.
Step three: start looking at financials- your own and the investment opportunity.
Caution
You need to know the worst case scenario for every passive investment opportunity is that you will lose your whole initial investment. That is the full risk. You could lose everything that you put into the deal. So the first thing you need to do is make sure you're going to be okay. If that happens, you will still have a roof over your head, food to eat and other basic necessities including a well established savings account and emergency savings. Next, understand where the returns are coming from in the investment opportunity. That sounds kind of obvious, right? It's coming from whatever asset the investment is investing in. But that isn't always the case. Sometimes the expected returns are based on the sale of the asset, so you won't get a return from the asset until it sells. So if you are getting distributions from the investment opportunity in the meantime, where are those coming from? Is it coming from your initial investment? Another thing to think about is what if the sale doesn't go as expected? If your returns are based on an expected sale and it doesn't happen? How will that affect your returns? Also, how's the operator making these decisions? Do they communicate with you when things go wrong? All of this information is in a document called the PPM, or the Private Placement Memorandum. Read a few of these before you invest. Usually this is broken down in simple terms in the pitch deck or offering memorandum, which is basically the presentation that the operators give to potential investors. Either way, check it over yourself and with a lawyer.
These are the three steps for you as a sophisticated investor to get access to real estate and group investment opportunities often called funds or syndications. Step one: find the operators- the people who put the deal together and run the deals. Step two: build relationships with them and ask lots of questions. And step three: look at the financials.