As you move through your investing career, you may have the good fortune of experiencing both real estate and business ownership. With that experience, you’ll form your own opinion on which you prefer. You’ll know which is best after considering just a few things mentioned in this article which has three sections: a general discussion, a deep dive and comparison chart, and how to fund the business or real estate acquisition.

Section 1: General Discussion

Personal Control in Real Estate vs in Your Business

If you have the energy and excitement to dedicate yourself full time to an endeavor that requires ingenuity, creativity, diligence and perseverance, then you might be happy buying and running a business. Investing in real estate probably won’t be as satisfying if you want to actively influence and control your investment.

Time and Energy Required For Real Estate vs Your Business

Running a business will require more of your time than a real estate investment or even a few properties. Even with a business acquisition that provides consistent cash flows, I highly recommend being active in the business that you acquire. You may be able to transition to more of an absentee-run business, but even a passive business is typically only semi-passive. So if you don’t have much time, you may not have the luxury of buying a business, but you can certainly get into or continue passive real estate investing.

If you take the real estate route, you may have extra time to make more money or enjoy life. See this article for more on the value of time and the relationship between time and money.

How much money can you make as a passive real estate investor versus running a business?

A lot can happen in both real estate and in business, so your analysis will depend on assumptions and projections. Long term real estate investing is slow and steady. A business has the potential to make more money faster, and also to lose money faster. Here are the things to compare:

Cash flow
Appreciation
Capital required
Return on Investment
Use of your time and value of your time

Let’s take a small business netting the owner $150,000 a year in adjusted net income. You may have to pay $300,000 to acquire that business (multiple of earnings = 2). Let’s say you invest the same $300,000 in an income property. You might net $40,000 per year on that property.

Now you have to consider a couple other things beside the net cash generated from your investment. How will your equity grow? Can you grow the profits to a consistent $200,000 in years 3-5? If so, the value assuming a multiple of 2 is now $400,000. Do you think your $300,000 property will be worth $400,000 in 5 years?

What if you make a $200,000 profit in years 3-5 even after paying yourself a salary? Compare that with passive real estate where you’re not paying yourself a salary, but simply benefitting from any positive cash flow from the real estate. Yes, you will have more time on your hands, and with that time you can make money in other ways. However, some real estate investments in high cost desirable markets do not cash flow right way.

Is Buying A Business More or Less Risky Than Buying Real Estate?

Wild business cycles can shut down a business if you can’t meet payroll or buy supplies. Real estate also has its cycles but if the value of your investment property drops, even below your purchase price, you can still hang on by collecting rent. It’s another story if you lose a tenant and can’t find a replacement.

Business ownership is riskier and has the potential to make, or lose, more money than real estate. The higher the risk, the higher the reward. How can we take advantage of a higher reward and mitigate risks? There’s a great saying in real estate and in business, “You make your money when you buy.” The way to mitigate business risk is to buy a track record of consistent cash flows and match your skills, experience and interest with the right business for you.

See Essential Tips for Buying a Business.

Cycles, Timing and Pivots in Real Estate and Business

Responsible investing in real estate, as with many other investments, means investing for the long term. Timing the market is not a prudent decision in most endeavors and is not a plan for success in real estate. Nonetheless, real estate investors need to monitor the real estate market and overall economy and learn how to periodically assess a real estate portfolio and balance it with 1031 exchanges.

In business, you should develop a cadence of strategy planning every three months after acquiring the business. In this planning session, you will evaluate the key functions of your business such as HR, operations, finance, sales, marketing and legal. You will also look outward at competition, the economy, the labor pool, supply chain, climate, and geo-political events. You will ask what you can do to grow, to be more profitable, to enjoy the business more, to shape a culture etc. You will always ask yourself one key question at these three month intervals – “should I grow or exit?” This framework and level of engagement will improve your ability to manage risks, deal with cycles, make pivots and actively add value. It requires much more engagement than monitoring real estate investments.

Both your real estate portfolio and your business require periodic evaluation with some adjustments. But in general, you’re in the real estate market for the long term. While your goal may be to be in your business for the long term, ask the “grow or exit” question quarterly and you’ll be better prepared if you need to exit early or if all signs indicate you should exit.

Section 2: Deep Dive and Comparison Chart

On the business side, we’ll compare a new franchise, a profitable ongoing business, and a profitable passive business. On the real estate side, we’ll compare passive real estate investing with home flipping.

Is it better to be a Passive Real Estate Investor or Flip Homes?

For the overwhelming majority of people, it is much better to be a passive real estate investor than a home flipper. Real estate tends to appreciate over the long term and that is one of the major positive attributes of the sector. Long term real estate investing is a passive endeavor, another positive attribute. Home flipping discards these two key attributes of conventional real estate investing for the opportunity to make money in the short term.

A buy-and-flip transaction with no remodeling and minor repairs takes less time than a remodel. However, if you are adding little to no value to the property, then you are relying entirely on a rising market to net a decent return after minor repairs, utilities and the costs of acquisition and sale. This is highly speculative activity due to the unpredictability of very localized real estate market shifts.

A fix-and-flip transaction with a major remodel takes time. The more time it takes, the more exposed this transaction is to a market shift and the longer the project is burdened with carrying costs. Timing is critically dependent on availability of labor and materials. Many contractors who help investors with fix-and-flip projects specialize in this type of work. That means they develop a reputation and are sought by other investors. You may need to incentivize them based on the completion timeline, but even then, you are competing with other investors who may also be incentivizing them or have a longer history with them.

Savvy real estate flippers are strategic. They know which municipalities are quick to approve building plans and which cities to avoid. They know that even a kitchen remodel may not pay for itself so they have to do other things to hedge against losses. They have to buy right, which means recognizing the potential in a low priced-fixer that is unlikely to have significant surprises. They choose to flip in a stable or rising market for extra cushion. They target projects with high return such as converting a 2-bedroom 1-bath home to a 2-2 or a 3-2.

Most investors are happy to make $50,000 to $100,000 per flip which could take six to nine months. Oftentimes, a flip will net considerably less or even lose money. There are many items on the expense side including labor, materials, permits, interest, utilities, property taxes, insurance, staging, advertising, commissions. There are also many impediments to the rapid turnaround needed to minimize carrying costs and market exposure including access to capital, labor shortages, material supply, permitting and approvals.

Flippers have a target called the 70% rule. As an example, in order to buy a home and sell it for $200k, known as the after-repair value (ARV), with an estimated $30k in repairs, the flipper must acquire the property for $140k – $30k = $110k. You can see how this might be a challenging search and acquisition. This is why they say you make your money when you buy.

Home flipping requires significant capital, labor on demand, significant skill in assessing acquisition opportunities, construction and marketing expertise, and real estate and economic markets that play nice. All of this creates a giant ball of risk. On top of all this, certain real estate markets can be just as profitable for passive real estate investors as flippers, but that’s on paper since passive real estate investors are long term investors. Flipping of any kind, other than burgers, is for highly skilled, highly engaged, risk takers.

A NOTE ON REAL ESTATE TIMING

Perhaps a few pundits can make the right calls about real estate cycles. But there aren’t many of them, and even fewer who get it right more than once. Even the ones who do get it right, are right “in general.” For example, if a pundit puts out warnings of an impending downturn in January and the downturn happens in July or even January of the next year, you might credit the pundit for making the right call. But that’s not the level of precision that a real estate flipper needs.
Investors consult with their real estate advisors (REALTORs, lenders, appraisers etc) for insights on the real estate market’s short-term future. Similarly, stock investors consult their advisors and news stations interview economists. Unfortunately, even the experts in the field have crystal balls that are not so clear.

Is it Better to Buy a New Franchise or Invest in Passive Real Estate?

For most people, I would say no to investing in a new franchise over passive real estate. The level of involvement is at the extremes from very high to very little. Yet, I don’t see a significant, if any, short term or long term financial benefit to starting a new franchise. Franchisors are interested in collecting fees and putting people to work in their system, not making them rich or nurturing creativity.

Most new brick and mortar franchises require significant capital above and beyond the initial franchise fee in store build outs, equipment and marketing expenses. The exception would be low overhead service companies. With service franchises, business-to-consumer services are highly competitive (real estate, carpet cleaning, house cleaning). While business-to-business services can be less competitive, they typically require significantly more experience and skill (business brokering, business consulting, accounting).

All franchises have major barriers compared to non-franchise businesses when it comes time to exit.

Buyer needs to be approved by Franchisor
Franchisor imposes a transfer fee
Franchise royalties and fees are a deterrent to business buyers
Poor performing franchises have potentially less leeway for improvement with a new owner

NOTE
I have owned real estate and business brokering franchises. That said, I would not recommend franchises to most entrepreneurs, especially brick and mortar B2C franchises. See this article on the challenges of franchises and franchising.

What about buying an ongoing profitable franchise?

I had a business seller who wanted to sell his pizza franchise after just a couple years in the business. The owner was a young entrepreneur who came from real estate investing. With experience as a landlord and seeing the long horizon required in real estate, he decided to expand into the pizza business to make money immediately. He was good with employees and operations, but made a few mistakes.

He did not follow the advice “Make your Money When You Buy.” When he told me how much he paid the previous owner for the franchise, I was surprised at how much he overpaid.
He treated the business from the mindset of a real estate investor, pouring significant funds into store buildout and expansion that would never pay for itself upon exit. He did the landlord and the new owner a favor.
He chose a location surrounded by lakes, requiring longer delivery routes than most other pizza businesses.
He bought a franchise with the highest royalties in the pizza industry.
He bought a brick and mortar franchise – period. As I mentioned, these franchises require a lot of work for little upside.

Is it Better to Buy and Run a Profitable Business or Invest in Passive Real Estate?

If you have time, energy, skills and passion, you are better off buying a profitable business than passively investing in real estate. Passive real estate investing won’t satisfy your needs for creativity and control in the same way as a business. Passive real estate also requires patience before realizing the benefits, something you may not want to consider if you have bottled up energy and a bias toward action.

You may have noticed a couple caveats attached to this recommendation. The first caveat is to buy a healthy and profitable ongoing business. Startups fail at a high rate, so buying a profitable business significantly reduces the risk of business ownership and brings the risk level much closer to the level of passive real estate investing.

The second caveat is to actively run the business. In the next section, we’ll touch on how and when to consider passive business ownership, an advanced endeavor that is often taken too lightly.

To fund your investment, you can pay cash or utilize a loan just as with investment real estate. SBA lenders like healthy profitable businesses. (They like them even more when real estate is part of the deal. Read about dealing with real estate when buying a business.) You’ll just need a down payment and the lender will also want you to have the skills to be successful at the business you wish to acquire.

When it comes time to exit, real estate always has value. It typically goes up over long periods of time. A successful business sale can be more challenging. However a profitable business on an up trend will look very attractive to a buyer compared to the many stagnant or declining businesses on the market.

In short, if you are excited to direct your energy and money into an active endeavor for immediate benefit, you should buy a profitable business. If you don’t have the time or level of commitment, then invest in passive real estate and be patient.

Is it Better to Buy a Profitable Passive Business or Invest in Passive Real Estate?

If you have an opportunity to buy a profitable business where the owner is absentee or semi-absentee, then this really warrants your consideration. Now that you have a passive business opportunity to compare to passive real estate, I would highly recommend the passive business on the condition that you immerse yourself as an active owner-operator for six months at a minimum, but ideally over a year, before transitioning to become an absentee or semi-absentee owner. I realize this condition messes up our apples to apples comparison of passive opportunities, but do not skip this step.

It will take self-discipline to curb your desire to do things your way right off the bat. Six months or more will afford you the time to bond with employees, learn the industry, meet key stakeholders, do a SWOT analysis, uncover areas missed by the previous owner, and make a strategic plan with metrics. A well thought out framework for how you will add value to your business will be invaluable. And take note of what exit planners say – “Start with the exit in mind.”

Read this article about how to succeed with passive businesses. If you cannot commit six, twelve or eighteen months to active ownership, resist the temptation to buy the passive business thinking you will make it work. Perhaps you think you can take a month off from your full-time job to learn the business, shuffle employees, tweak incentives, delegate and then go back to your job. You have to consider the fact that the prior owner was able to create a successful passive business by developing expertise and relationships over time, not overnight.

See Multiple Offers When Buying a Business vs. Real Estate.

Buying a Business Compared to Real Estate

	Buy and Hold Real Estate	Flip Homes	Buy and Run New Franchise Location	Buy and Run Profitable Business
Short Term Benefit	LOW	MEDIUM	LOW	HIGH
Long Term Benefit	HIGH	NA	LOW	MEDIUM
Required Funds	MEDIUM Down payment	HIGH Cash purchase, repairs, permits, marketing	HIGH Franchise fee, real estate buildout, start-up fees	MEDIUM Down payment
Ability to Borrow	HIGH Traditional lenders	LOW Private investors	LOW No cash flows to support a loan	HIGH Traditional SBA lenders
Acquisition Skills	MEDIUM Evaluate suitability as a rental	HIGH Evaluate suitability as a construction project, as a rental, and as a home	LOW Franchise documents and call current owners	HIGH Evaluate quality of earnings, potential, many moving parts, few good comparables
Management Skills	LOW Property management, construction trades	HIGH Incentivize contractors on speed, quality, expertise, communications	LOW – HIGH Restaurant, retail, B2C service run franchise formula / B2C services require higher skills	HIGH Speed, skills, incentives, communications, permits, expertise and recommendations
Market Exposure to Risk	MEDIUM No control over market but real estate generally rises over long term	HIGH No control over market which can turn quickly mid-project/s	HIGH No control over market forces	HIGH No control over market forces, but able to mitigate risks
Exit Pressure or Challenge	LOW Seller’s market comes and goes and comes back gain	HIGH Carrying costs are killers, ideally sell prior to completion	HIGH Franchise investments, royalties and low ROI are challenging	MEDIUM Ideal exit when profitable and trending up
Investor Effort	LOW	HIGH	HIGH	HIGH

Section 3: How to Fund a Business or Real Estate Acquisition

How Can I Fund a Business Acquisition or Real Estate Investment?

A lot depends on financing and deal structure. But at the very low end of things, it can be easier to buy a business for cash than real estate for cash. This answer may surprise you if you are unaware of startup and online businesses, many of which sell for well under $50,000. You can even find businesses to choose from under $25,000. Many real estate markets have zero listings at these low prices. Income properties at these low prices will often require additional capital for repairs or will be in undesirable neighborhoods. See this article on how to buy a business with little money.

Loans

Loans are available for businesses just as they are for real estate. Business loans are backed by the SBA whereas many real estate loans are backed by Fannie Mae, Freddie Mac, and Ginnie Mae which are quasi-government agencies.

Seller Financing

Seller financing is also available for business acquisition or real estate, although it is much more prevalent in business acquisitions. Most seller financing for business transactions is well under 50% of the purchase price. With seller financing, the seller acts like a bank, and typically requires a personal guarantee from the buyer just as a bank would. The Seller receives consistent monthly payments with interest regardless of the performance of the business.

Earnouts

In business acquisitions, the deal can also be structured with earnouts. This means some portion of the offer will be paid to the Seller in the future after certain milestones are reached. Earnouts can be set for any time period.

Retirement Loan

Retirement funds are another source of capital for buying a business or real estate. You can borrow up to $50,000 from your retirement account and use it for either purpose, but this is a loan from your retirement so you need to make monthly payments with interest back to your retirement account. The term of the loan is a short five years which makes the payments relatively high. This loan is a great short term bridge until other income arrives from the business, the real estate, or some other source.

Invest Retirement Funds

Another way to borrow from retirement is to have the retirement fund invest in your business or real estate. There are financial intermediaries that specialize in establishing retirement funds to purchase real estate (self-directed IRA or SDIRA), and still others that can help you establish retirement accounts to invest in a business (ROBS). The nice thing about these types of investments is they are not loans that require monthly repayment.

The catch is that all proceeds that come from your investment must go back into your retirement account. In that sense, this is not money you can access for personal use outside the retirement account. However, if you invest in a business via a ROBS account, you can pay yourself a salary and those earnings can be utilized for personal use outside your retirement account. With an SDIRA invested in real estate, you are not allowed to pay yourself for sweat equity, commissions, property management, etc. Check with your CPA to verify the current rules of ROBS and SDIRA accounts.
See this article to learn more about buying a business with little funds or with retirement funds.

Is it Better to Buy a Business or Invest in Real Estate?