Unlocking Real Estate: The Benefits Of Investing In Funds

Real estate is a popular investment vehicle, and for good reason. There are many benefits to investing in real estate, including the ability to generate passive income, stable cash flow, tax advantages, diversification, and leverage.

One of the main benefits of investing in real estate is the ability to generate passive income. With rental properties, investors can collect rent from tenants, providing a steady stream of income. Additionally, real estate values and rents tend to increase over time, leading to higher cash flow and potential profits when it's time to sell.

Another advantage of investing in real estate is the diversification it offers. Real estate has a low correlation with other major asset classes, meaning it can lower the volatility of an investment portfolio and provide a higher return per unit of risk.

Real estate investment trusts (REITs) and real estate funds are also popular options for those looking to invest in real estate without the hassle of owning and managing properties directly. These investment vehicles allow individuals to pool their capital together and invest in a variety of properties, providing diversification and the potential for higher returns.

Overall, investing in real estate can be a great way to build wealth and generate stable income, offering a range of benefits that make it an attractive option for investors.

Diversification of your portfolio

Real estate is considered its own asset class, and as such, it should be a part of a well-diversified portfolio. Adding real estate to a portfolio of diversified assets can lower its volatility and provide a higher return per unit of risk.

Real estate investment funds, in particular, offer investors broad exposure to the real estate sector. They typically own many property types or invest in several different REITs (real estate investment trusts). Diversification helps reduce risk, although it can also lower an investor's return potential.

Real estate funds are also a great way to diversify your portfolio without the hassle of owning property directly. They are a mutual investment entity, allowing investors to invest any amount of money they choose toward numerous properties at the same time. This means investors can circumvent the need to have the entire capital amount that would be required to invest in whole properties as an individual. Instead, they can purchase a portion of several properties in the form of shares.

Real estate funds also allow investors to diversify across asset types, markets, and appreciation profiles. For example, some real estate funds focus on large residential properties, while others might be focused on commercial properties that can be renovated and sold quickly. Diversification lowers risk while increasing the potential for greater returns for investors.

Additionally, real estate has a low—and in some cases, negative—correlation with other major asset classes. This means that when stocks are down, real estate is often up. The more direct the real estate investment, the better the hedge: less direct, publicly traded vehicles, such as REITs, are going to reflect the overall stock market's performance.

Finally, real estate funds can be structured as REITs, which are open-end mutual funds that can trade on a stock exchange. This provides liquidity and can provide diversification within your portfolio.

Lower entry costs

Real estate funds pool investors' money to purchase properties, which has the benefit of lowering the entry costs for individual investors. This is because the funds allow investors to buy shares in a set of similarly rated assets in different locations, rather than having to purchase an entire property themselves.

Real estate funds, therefore, provide a much lower entry point than investing in individual properties. For example, most real estate funds have initial investment thresholds of less than $10,000 for a mutual fund and around $100 for a real estate ETF.

In addition, real estate investment trusts (REITs) are a type of real estate fund that is publicly traded and tends to have even lower minimum investment requirements. REITs are also available for investment inside most standard retirement savings accounts.

As a result, real estate funds are a great option for investors who want to get into the real estate market but can't afford to buy an entire property. They are also a good choice for those who want to diversify their assets by investing in multiple properties or different types of real estate.

Other Benefits of Real Estate Funds

Aside from lower entry costs, real estate funds offer several other advantages, including:

• Diversification: Real estate funds typically offer broad exposure to the real estate sector, investing in multiple property types or REITs. This helps to reduce risk and enhance returns.
• Passive investing: Real estate funds are hands-off investments, as the active management of the properties is handled by others.
• Higher returns: Real estate funds often provide higher and more consistent returns than other investments, and these returns are independent of stock market fluctuations.
• Tax advantages: Real estate funds offer tax benefits, such as the ability to defer taxes on income and capital gains until shares in the fund are sold.

Passive income

Real estate funds are a passive way to invest in the real estate sector. They are a type of mutual fund that invests in public real estate securities, including real estate investment trusts (REITs).

Diversification

Real estate investment funds offer investors broad exposure to the real estate sector. They typically own many property types or invest in several different REITs. Diversification helps reduce risk, although it can also lower an investor's return potential.

Lower initial investment threshold

Most real estate funds have relatively low initial investment thresholds, usually less than $10,000 for a mutual fund and often less than $100 for a real estate exchange-traded fund (ETF). This provides investors with a much lower entry point than if they were to buy individual properties.

Real estate enables investors to generate passive income as tenants pay rent, but being a landlord requires active management. In contrast, real estate funds are much more hands-off investments since others handle the active management of the properties.

Liquidity

Passive real estate investing offers better liquidity than active investing and will take up less of your time since you are not managing a property.

No expertise necessary

Passive real estate investing doesn't require extensive real estate knowledge or experience. You can invest in a real estate fund without knowing how to manage an investment property.

Less work

There is usually no physical labour or work involved with passive real estate investing – you just invest your money and watch it grow.

Steady income

Real estate investment funds, particularly those that invest in REITs, tend to provide a steady stream of cash through regular dividend payments.

Appreciation

While some real estate funds pay dividends, others earn returns for their investors via capital appreciation.

Professional management

Real estate funds are professionally managed, so investors don't need to spend time doing extensive research to figure out where to put their money.

Tax advantages

Investing in a real estate fund can offer several tax advantages, providing investors with opportunities to reduce their tax liabilities and enhance their overall tax efficiency. Here are some key tax advantages to consider:

• Tax Write-Offs and Deductions: Real estate investors can take advantage of various tax write-offs and deductions directly related to the operation, management, and maintenance of their properties. These may include property management fees, repair and maintenance costs, property insurance premiums, legal and accounting fees, and travel expenses related to property management.
• Depreciation Deduction: Investors can deduct rental property depreciation as an expense over the expected life of the property. The IRS currently sets this period at 27.5 years for residential properties and 39 years for commercial properties. This deduction lowers taxable income and may reduce overall tax liability.
• Pass-Through Deduction: Rental property owners can use a pass-through deduction to deduct up to 20% of their qualified business income (QBI) on their personal taxes. Rental income is considered QBI, and this deduction can provide significant tax savings.
• Capital Gains Tax Treatment: Holding onto real estate investments for the long term (over one year) can result in more favourable tax treatment. Long-term capital gains are typically taxed at a lower rate than short-term gains, and in some cases, investors may qualify for a 0% tax rate.
• Self-Employment Tax Reduction: Self-employed individuals usually pay a substantial portion of their income towards FICA taxes (Social Security and Medicare). However, rental income from real estate investments may not be subject to FICA taxes, resulting in notable tax savings.
• 1031 Exchange and Opportunity Zones: The government offers tax incentives to encourage investors to reinvest profits into new real estate deals or invest in designated low-income areas known as Opportunity Zones. These programs allow investors to defer or potentially eliminate capital gains taxes, providing further tax advantages.
• Diversification and Lower Volatility: Real estate investments can lower the overall volatility of an investment portfolio and provide a hedge against inflation. This diversification can lead to a higher return per unit of risk and enhance the risk-and-return profile of an investor's portfolio.

Competitive risk-adjusted returns

Risk-adjusted returns are a fundamental concept in finance, but one that many investors don't fully grasp. Essentially, it is a calculation that evaluates the profitability of an investment relative to the level of risk undertaken. In other words, it helps determine whether the potential returns of an investment are worth the risks involved.

Risk and Return

In theory, there is a positive correlation between risk and return. Stepping out on the risk curve generally leads to higher returns. For example, a low-risk core deal, such as purchasing an unleveraged trophy office tower in Manhattan, yields lower returns than riskier investments. Each incremental step further out on the risk curve—moving from core-plus to value-add and opportunistic investments—should produce a corresponding increase in returns.

Measuring Risk

The most common way to measure risk is by using the Sharpe ratio. This ratio calculates the excess return generated by an investment for the additional volatility endured by holding a riskier asset. It is determined by using standard deviation and excess return to ascertain the reward per unit of risk.

The higher the Sharpe ratio, the better the asset's historical risk-adjusted performance. The Sharpe ratio allows for a direct comparison of the risk undertaken by two assets to earn excess returns over the risk-free rate.

Real Estate Risk and Return

When considering real estate investments, it is important to understand the relationship between risk and return. For instance, investing in a Class A apartment building in a core market is generally considered less risky than investing in a Class B or C apartment building in a secondary or tertiary market.

Additionally, the age of the property plays a role in determining risk. Newer properties are associated with lower risk regarding major capital expenditures, such as roof repairs or heating system replacements. Conversely, older properties carry a higher risk of requiring significant investments to replace or repair major building components.

Real Estate Funds

Real estate funds pool investor money to collectively purchase properties, diversifying risk and lowering entry costs. They are a passive investment option, allowing investors to generate income through rent payments without the active management responsibilities of being a landlord.

Real estate funds, particularly mutual funds and ETFs, are accessible to a wide range of investors, offering broad exposure to the real estate sector. They typically own multiple property types or invest in several different REITs, providing diversification and reduced risk.

Final Thoughts

Real estate funds offer competitive risk-adjusted returns by providing investors with access to diversified real estate investments. The passive nature of these funds frees up investors' time while still enabling them to participate in the real estate market. By pooling investor capital, these funds lower the initial investment threshold, making real estate investing more accessible.

Frequently asked questions