The Passive Income Quandary

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Which passive investment camp do you fall under?

Are you in the camp seeking passive income to increase your retirement savings with safe consistent returns? Or do you fall under the camp seeking to build wealth through a compounding passive income stream?

No matter which camp you fall under, no doubt you’ve considered both stocks and real estate as passive investment options and the reason you’ve sought out passive income opportunities is because you either don’t have the time or feel like you don’t possess the expertise to actively trade stocks or actively invest in real estate.

For passive income, the most common vehicle in the stock market is through mutual funds. And for real estate, although many passive income options are available, many of these options like REITs are tied to the stock market so for purposes of this discussion, we will stick to the non-stock market passive investment options.

And among the most popular of these options is the investment in a private real estate investment fund or syndication. So, when faced with the passive investment options between mutual funds and a private real estate fund, what are the most important factors to consider? Besides return as being the most obvious consideration in choosing between two different investment options, there are other factors you should consider that you may not have thought about. Here we present a summary of the considerations.

Return

The performance of the average mutual fund is likely to mirror the S&P 500. The S&P 500 Index’s average annual return over the past 20 years is approximately 8.6%. Average annual returns from commercial real estate during the same period averaged 9.5%. Residential and diversified real estate investments averaged 10.6%. Assuming fees being equal between mutual funds and private real estate funds, the inference is that average returns from passive real estate investments exceed those of mutual funds. In addition to the advantage in average annual return, passive real estate investments hold additional advantages, not on the top of investors’ minds.

Passive income generated from productive assets should continue to produce even in bad times.
Recession Hedge

As a hedge against bad times, the advantage of passive real estate investments is clear. In a recession, stocks correlate with the broader economy. As the economy goes, so too does the value of stocks and logically, the value of mutual funds. Real estate investments, as a class of alternative investments, are by nature uncorrelated to the broader market. Passive income generated from productive assets should continue to produce even in bad times. Income generating real estate will not suddenly cease providing rental income and some classes of real estate have even proven to actually thrive in a recession due to the constrained supply of affordable housing currently existing in the market.

Investment Secured by Tangible Asset

Mutual funds and stocks, in general, are not tangible assets. When the value of stocks plunge, there is no tangible asset backing up the stocks to salvage value from. With passive real estate investments like debt or equity investments in a private real estate fund, your investment is often secured by a physical asset. When all is lost, there is always the value of the underlying value of the real estate that can be liquidated to salvage your investment. With stocks, there is no underlying tangible asset, so when all is lost, there is nothing left to salvage.

With stocks, there is no added benefit from appreciation like an investment in a tangible asset like rental real estate. When you combine the security aspects along with the appreciation benefits of a tangible asset like real estate, there’s no comparison for the passive investor between real estate and stocks.

Control

With mutual funds, you are at the mercy of faceless fund managers whose investment strategies are at their sole discretion. With private real estate funds, you maintain control of how your funds are invested by choosing who to invest with. If you prefer to invest in commercial real estate, then you can choose to invest in a commercial real estate fund.

Oftentimes, with special purpose funds, you can invest in specific properties like a specific professional tower or apartment complex. With some funds, you can also maintain somewhat control over your rate of return as many private real estate funds offer preferred annual returns often ranging from 6-8%. And with private real estate funds, you are not at the mercy of faceless managers. With most private real estate funds, the fund sponsors are often accessible from introduction through the life of the fund.

For the investor looking to build wealth through passive investments, the choice between passive real estate investments and stock investments is clear. For average returns, security, control and as a hedge against bad times, there is no comparison.

However, as with any investment, it’s important to do your due diligence as just as there are poorly managed mutual funds there are also poorly manage private real estate funds. But, all things being equal, the choice is clear.

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Comments (1)

Is it possible to invest proceeds from realestate sale in 1031 partnerships in senior trailer parks? Sorry this is not a comment but a question

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