The Big Difference in Passive vs. Active Investing

[Don Konipol]

I used to think that the “big difference” , The “great divide” in investments was between equity and debt.  A number of years later I revised my thinking and thought “business vs real estate”.  Then I came to the conclusion it was “risky vs safe”.  While all these are “dividers” they are not the ultimate divide.  After 45 years investing across many asset classes, many investment types, and everything from lowest risk to outright gambles, I think I finally know the answer.

The biggest divide is between investments in which operational control over that investment is with the investor, and investments in which control rests with another party.  The only “control” an investor has when he invests in REITS, (or any stocks for that matter), mutual funds, real estate syndications, whether debt or equity, or minority shares in a business, is whether to keep or to sell his investment, and often not even that.  When things go wrong the “passive investor is helpless to do anything about it; sure he can display his displeasure by emailing the “sponsor/manager”, complaining on BP or Facebook; report his frustration to a governmental agency.  But, he has no ability to take any corrective action he feels is necessary or beneficial.  He’s at the mercy of someone else’s expertise, motivations, personal interests, perception, and knowledge.  

I’ve heard investors on this forum describe investing in notes (directly) as a passive investment.  BS!.  

Nothing could be further from the truth.  The most obvious example is when a borrower misses a payment, or two, or three.  The note investor has many choices of action to consider.  He can try “cajoling” the debtor into making payments.  He can initiate foreclosure proceedings.  He can try to work out a modification of the loan in some way, and there are literally dozens of different types of modification that may be appropriate for any given situation and may prove beneficial for both parties.  He can extend an additional loan to the borrower, especially if the borrower has additional collateral to put up.  And he can purchase the property himself from the defaulting borrower, or purchase a (majority) ownership in the subject property.  I have used all of these to deal with a loan in default.  Not anywhere close to a “passive” investment. 

But, the note doesn't have to be in default for the note holder to engage in actively "managing" the note. If the note holder purchased the note at a discount he can accelerate his profits and increase his ROI by offering the borrower an incentive to pay off the note early, or to make e extra payments. The note investor can set up a deal where the borrower deeds part of the property to him for cancellation of a certain amount of principal. Or where the borrower sells the property to a third party with the assumption of the note - at an increase in interest rate. No, note investing is not passive at all.

I was seriously contemplating moving a large share of my investment portfolio into “passive” type investments, where I left the management of the investment up to someone else.  But, for me, something didn’t sit right.  So I got to thinking about it, and hence my thoughts that led to this post.  Along the way I remembered something the great note investor and early real estate investing teacher Jimmy Napier said to me.  I had asked him why he never invested in syndications, REITS, or minority interests.  He said it was because he didn’t want anyone else to VOTE on his money.  

So, what do YOU think?