All investors, regardless of what they invest in, want to maximize their reward while minimizing risk. In real estate, there’s no clear cut metric to measure risk and reward.
Today, Lon Welsh joins me to compare directly owning real estate (active investing) to passive investing in today’s economy. Lon has overseen thousands of transactions as the founder of Your Castle Real Estate. As the founder of Ironton Capital, he is well-versed in passive investing, too.
- Listen to the podcast “#406: Is Active Real Estate Investing Too Risky in a Recession?” Denver Real Estate Investing Podcast
- Watch the YouTube video (at the bottom).
- Read the blog post. Note, the blog is an executive summary. Get the in-depth breakdown from the podcast or video.
Why Do People Look at Passive Investing over Active Investing?
When Lon talks to people about why they don’t want to invest in real estate, the response he hears most often is that they’re too busy—they have jobs, kids, and no time to manage real estate. As an active investor for two decades, Lon understands this outlook. It takes time and energy to own real estate, and now he, too, is ready to give up the extra work.
Sometimes active real estate will outperform passive investments, but we’re not in that phase of the economic cycle right now.
What’s the Best Reason to Passively Invest?
The diversification in passive investing reduces risk through three important factors—geography, asset class, and strategy. In active investing, you tend to own one type of property in one area while using one strategy. Passive investing allows you to invest all over the country in all types of properties, from office buildings to hospitality. Each investment can use a different strategy—value-add, development, buy and hold, etc.
The ideal portfolio has all of these diverse qualities.
How Do Passive Investments Perform against Direct Ownership?
Over the past 20 years of investing, Lon has seen over 20% returns per year through his active investments. This is largely due to being in the right place at the right time: he bought a lot of condos at the low point of the market and got great returns on them as the market rebounded.
More recently, though, he’s struggled to get to 20%. Even though rents are increasing, prices are going up at a faster rate.
Ironton Capital has five investment funds that are providing solid returns. The first and fourth funds are tracking at 20%; the second and third in the 15%-16% range, and the fifth is targeting 14%-20% and will likely end up around 17%.
In the current economic cycle, active and passive investments are producing similar returns, but one is a lot more work than the other.
What Are the Risks of Active Investing in a Recession?
As we likely head into a recession, the biggest risk for landlords is that higher quality products will reduce rents and lure tenants away. Tenants will be able to pay the same rent for a nicer place to live, so why would they choose the lesser quality property? It will be a battle to attract tenants, and landlords will have to do more work with a less nice property.
In order to incentivize people to rent from you, you may have to give up things like a security deposit and run the risk that tenants won’t pay. It likely won’t be that bad in Denver, but we will experience a level of uncertainty.
Why I’m Turning to Passive Investing
My active investments are focused on one asset class and are all close together geographically. From a portfolio perspective, that’s not great diversification. I’m lowering my risk by passively investing, which also frees up a lot of my time.
Get more information about Ironton Capital’s strategy and funds by watching this webinar.