Real Estate Fund Investing: What You Need To Know

Real estate is a popular investment vehicle, and for good reason. It can be a sound investment strategy that provides a steady income and builds wealth over time. There are many ways to invest in real estate, from owning physical property to investing through funds. Real estate funds, such as mutual funds and ETFs, pool money from multiple investors to purchase properties, diversifying risk and lowering entry costs. They are a passive way to invest in the real estate sector, providing investors with broad exposure to the market for a small investment.

When considering investing in real estate through funds, it is important to understand the different types of funds available, such as mutual funds, ETFs, and private equity funds, each with its own advantages and suitability for different types of investors. It is also crucial to weigh the pros and cons of real estate investing in general, including the potential for additional income streams, portfolio diversification, and tax benefits, against the drawbacks, such as the illiquidity of direct property investments and the time and effort required to manage them.

Overall, investing in real estate through funds can be a great option for those looking to add real estate exposure to their portfolio, especially for those just starting their real estate investing journey.

Real Estate Investment Trusts (REITs)

REITs own, run, or finance income-producing properties such as apartment complexes, data centres, healthcare facilities, hotels, infrastructure, office buildings, retail centres, self-storage units, timberland, and warehouses. They tend to specialise in specific real estate sectors, like commercial properties, but many hold diversified portfolios of many kinds of properties.

REITs are bought and sold on major exchanges, just like stocks and exchange-traded funds (ETFs). They are highly liquid, unlike traditional real estate investments. They are also subject to specific tax implications that should be considered, as they can greatly impact returns.

REITs are typically divided into three categories:

• Equity REITs: Most REITs are equity-based and own and manage income-producing real estate. They generate revenue primarily through rent.
• Mortgage REITs: Mortgage REITs lend money to real estate owners and operators directly through mortgages and loans or indirectly through mortgage-backed securities. Their earnings are generated by the net interest margin.
• Hybrid REITs: These trusts mix strategies from equity and mortgage REITs.

There are also different ways to purchase REITs, including:

• Publicly traded REITs: Shares of publicly traded REITs are listed on a public exchange and fall under U.S. Securities and Exchange Commission (SEC) regulations.
• Public non-traded REITs: These REITs are registered with the SEC but are not traded on exchanges, making them less liquid. Shares can be bought through a broker or financial advisor.
• Private REITs: These REITs are not registered with the SEC and don't trade on securities exchanges. They are generally sold only to institutional investors and are the site of many REIT-related frauds.

REITs offer potential benefits such as stable cash flow through dividends, attractive risk-adjusted returns, and diversification. However, there are also drawbacks, including sensitivity to interest rate changes, economic downturns, and sector-specific challenges.

When considering investing in REITs, it is important to do your research, start small and scale up gradually, diversify across REIT categories, and be aware of the tax implications.

Real Estate Mutual Funds

Benefits of Real Estate Mutual Funds

One of the key advantages of real estate mutual funds is the ability to gain diversified exposure to the real estate market with a relatively small amount of capital. The fund managers' expertise and research capabilities provide valuable insights into specific real estate investments and the overall performance of the asset class.

Additionally, real estate mutual funds offer dividend income and the potential for capital appreciation, making them attractive to medium- and long-term investors. The value of real estate also tends to increase during inflationary periods, as property prices and rents rise, providing a hedge against inflation.

Risks and Considerations

While real estate mutual funds offer benefits, it's important to remember that returns are not guaranteed. Sector-specific funds, including those focused on real estate, tend to be more volatile than funds with broader holdings. As the real estate market fluctuates, these funds can experience significant impacts.

Furthermore, rising interest rates can affect the returns of real estate funds. When interest rates increase, the cost of borrowing rises, which can reduce profits for REITs that rely on borrowed money to purchase properties.

Examples of Real Estate Mutual Funds

• T. Rowe Price Real Estate (TRREX)
• Fidelity® Series Real Estate Income Fund
• PGIM US Real Estate Fund
• Baron Real Estate Income Fund
• BlackRock Real Estate Securities Fund
• Cohen & Steers Instl Realty Shares

Real Estate Exchange-Traded Funds (ETFs)

REITs were created by Congress and signed into law by President Dwight Eisenhower in 1960 to encourage real estate development and give all investors access to the benefits of owning rental property. They can be private companies or publicly traded, and they trade on major stock exchanges.

There are three types of REITs:

• Equity REITs: These own real estate directly.
• Mortgage REITs (mREITs): These own real estate financial instruments, such as mortgages or mortgage-backed bonds.
• Hybrid REITs: These have direct ownership in real estate and own mortgage paper.

Firms incorporated as REITs can avoid paying corporate income taxes if they distribute a minimum of 90% of their taxable income to investors. As a result, they can often distribute a substantially higher income to shareholders.

ETFs that specialize in REITs can be beneficial to investors, offering a level of diversification that would be difficult or impossible to achieve otherwise. They are also professionally managed, which is valuable, especially for retail investors who may not have the time to research the market.

• Invesco KBW Premium Yield Equity REIT ETF (KBWY): This ETF has a low expense ratio of 0.35% and focuses on small-cap and mid-cap REITs.
• Nuveen Short-Term REIT ETF (NURE): NURE aims to track the Dow Jones U.S. Select Short-Term REIT Index, providing exposure to REITs with short-term lease agreements, which are less sensitive to interest rate changes.
• Virtus Real Asset Income ETF (VRAI): This ETF offers exposure to a basket of equities in the real estate, natural resources, and infrastructure sectors, providing growth opportunities and potential inflation protection.

REIT ETFs can be a great way to gain exposure to the real estate market, offering diversification, professional management, and potential for dividend income and capital appreciation.

Real Estate Private Equity Funds

How They Work

Private equity real estate funds involve the acquisition, financing, and ownership (direct or indirect) of properties using capital pooled from outside investors. The funds then develop the properties for a short period before selling them.

Structure

In a fund structure, a sponsor leads a fundraising effort for a specific fund, and investors allocate capital for the purpose of general real estate investment. Investors generally have no say in which properties are pursued.

There are two groups of partners in a private equity real estate fund:

• General Partner (GP) or Fund Manager: They are responsible for raising investment capital, property identification and due diligence, property and fund management, and legal and tax compliance.
• Limited Partners (LPs): These are the investors who want to earn a return on their capital. The LP role is passive, meaning LPs have no say in property or investment management decisions.

Pros and Cons

The biggest benefit of investing in private equity real estate is the potential for high returns. Private equity investors are entitled to a portion of any income or profits made from each underlying investment. Additionally, investors benefit from diversification as these firms tend to invest in a wide variety of real estate assets.

However, working with a private equity firm often comes with management fees and other costs in addition to the minimum contribution. These funds also tend to be illiquid, requiring investors to hold their contributions for several years.

Types of Private Equity Real Estate Funds

There are four main types of private equity real estate funds, each offering different levels of risk and return:

• Core Funds: These funds invest in high-quality, high-value real estate assets, such as fully leased multifamily properties. They offer predictable cash flow but typically generate lower returns due to the low level of risk.
• Core-Plus Funds: Core-plus funds offer a mix of core and value-added properties, providing slightly higher returns in exchange for a higher level of risk.
• Value-Added Funds: These funds purchase properties that may be slightly run down but have potential for improvement. They involve taking on a medium-to-high level of risk but offer the potential for greater returns.
• Opportunistic Funds: Opportunistic funds provide the greatest opportunity for returns but also carry the highest level of risk. They often invest in high-risk/high-return properties or projects, such as ground-up real estate development.

Real Estate Investment Groups (REIGs)

A real estate investment group (REIG) is a group of private investors who come together to pool their money, knowledge, and time to purchase properties that generate income. REIGs are typically formed as legal entities and can take on a variety of structures, including partnerships and corporations. The group's investment strategy may involve buying, renovating, selling, or financing properties, with the goal of maximising profits.

In a typical REIG, the company buys or builds a set of apartment blocks or condos and sells them to investors, who then become part of the group. Each investor can own one or multiple units within the complex. The REIG manages all the units, taking care of maintenance, advertising, and finding tenants. In exchange, the REIG takes a percentage of the monthly rent.

One of the key advantages of REIGs is the pooled capital they receive, allowing for larger investments and potentially greater returns. REIGs also benefit from diversification, as the group brings together individuals with different areas of expertise, such as real estate professionals, investment analysts, and accountants. This can help lower risk and enhance investment decisions.

However, there are also some potential drawbacks to consider. REIGs often have formal agreements that may restrict members' access to their money. Additionally, there may be set fees associated with the group, which can eat into profits, especially if the returns are slim or losses occur. The success of the group also depends on the skills and experience of the people making the investment decisions.

When considering joining a REIG, it is important to conduct thorough research and due diligence. This includes evaluating the group's investment strategy, track record, transparency, and regulatory compliance. It is also crucial to assess the management team's experience and expertise.

Frequently asked questions