Many people looking to invest in the real estate market opt for real estate mutual funds because they provide a simple and affordable way to invest in the lucrative sector. They also present a more liquid and widely varied investment vehicle into real estate than direct ownership. But are they any good?
Real estate mutual funds are a good investment because they are easy to invest in, generate good returns, and provide an affordable way to invest in the expensive real estate market. They also allow you to diversify your investments. Their main con is their dependence on the market’s performance.
The rest of this article will delve more into a few topics related to real estate mutual funds in more detail. We’ll define real estate mutual funds, discuss how they work, and go over their pros and cons. We’ll also tell you what to consider when investing in real estate mutual funds.
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Table of Contents
What Are Real Estate Mutual Funds?
Real estate mutual funds are a type of professionally managed pool of funds that invest in REITs (Real Estate Investment Trusts), real-estate stocks and indices, or a combination of them.
Multiple investors deposit money into the pooled funds, after which the fund managers invest the combined capital into various properties as a single managed portfolio.
To do their work effectively, these mutual funds employ expert research and professional portfolio managers.
There are two types of real estate mutual funds: open-end or closed-end. Moreover, they can be managed either actively or passively. Passive investing in real estate means investing with little to no hands-on effort or active involvement.
Investment in a real estate mutual fund can be both passive and indirect since there is no daily management, and it doesn’t entail investing in a particular piece of real estate. In addition, investors receive passive income in the form of dividends from the funds. Direct investing occurs when the mutual fund invests directly in real estate.
Close-ended real estate mutual funds are referred to as REITs. These firms own, develop, and manage income-producing real estate properties. And since they get listed on the stock market, you can buy and sell them like regular shares.
Open-ended funds, on the other hand, issue new units when their demand increases. Thus, their prices rise and fall depending on the fund’s popularity and the value of its investment properties.
Who Can Invest in Real Estate Mutual Funds?
Individuals without large amounts of capital to buy property can invest in real estate mutual funds. They are also suitable for investors who don’t want the hassles of owning property directly.
However, they are not suitable for short-term investors because they require a minimum investment horizon of 3-5 years.
How Do Real Estate Mutual Funds Work?
Real estate mutual funds, as mentioned, invest in securities of real estate-based companies. These are typically large-scale commercial projects, residential complexes, land, or easy to value assets in certain real estate.
Such funds provide real estate companies with the capital to develop their properties. And if the developments result in positive growth, the fund makes positive returns.
Profits that accrue from investing in real estate mutual funds remain in the fund until you decide to sell. Factors that impact overall returns on real estate mutual funds investments include the below:
- Interest rates.
- Conditions in the real estate market.
- The supply and demand of commercial and residential properties.
Real Estate Mutual Funds Pros and Cons
Investing in real estate comes with its share of advantages and disadvantages.
Pros
Let us first examine some of the benefits that make these funds a good investment.
- They provide a hassle-free alternative to purchasing investment property.
- They can help boost your investment returns by providing dividend income.
- They are great at protecting against inflation since real estate value increases with inflation as rents and property prices shoot up.
- Investing in real estate mutual funds during low-interest rate periods combines stock liquidity with the anticipated huge returns from property investments.
- They offer medium and long-term investors the opportunity for potential capital appreciation.
- They give you diversified exposure to the real estate sector without using enormous amounts of capital. Diversification also means increased investment stability since price fluctuations get balanced out because of investing in multiple residential or commercial properties across different locations.
- They allow investors to access a much broader asset selection than they would by merely purchasing REIT stocks.
- They give investors the ease and flexibility to choose the amount they want to invest and the ability to move from one type of fund to another.
- They provide investors with valuable analytical and research data. This includes information on the fund’s acquired assets plus the management’s perspective on the viability of various real estate investments.
- Unlike the low liquidity associated with investing in real estate—selling property takes time—real estate mutual funds are highly liquid, allowing you to liquidate your investments with relative ease.
- You can get tax breaks on your investments if you own property funds in a pension, a scenario that’s unlikely when you buy property directly.
Cons
Investing in real estate mutual funds exposes you to the following risks:
- Projected gains might not always materialize, or guaranteed returns might not always be the outcome.
- Sector-specific funds like real estate mutual funds are more prone to volatility than funds sporting wider investment horizons.
- Since the real estate market depends on the demand for properties, the funds earn good returns only if the markets perform. But when the opposite happens, the fund’s performance goes down. This also means that a crisis in the sector affects the real estate mutual funds too.
- Prevailing interest rates have a direct effect on the real estate market since they affect borrowing rates.
- The fund’s charges could eat into your returns, thus reducing your gains. Besides, while a fund’s performance reflects the general property market, it also relies on the fund manager making the right call regarding when to buy or sell a given property. This means that you cannot decide on what companies the fund ought to invest in.
What To Consider When Investing in Real Estate Mutual Funds?
If you choose to invest in real estate mutual funds, consider the following:
- Conduct lots of research on potential real estate mutual funds. Find out who runs the mutual funds, their management fees, the minimum investment amount required, and the companies they invest in. In addition, pay special attention to the fund’s investment goals and strategies as well as the associated risk levels since they should align with or complement your own.
- The size of the real estate mutual fund. Large mutual funds are ideal for beginner investors looking to build their investment portfolio. This is because they are highly diversified and generally inexpensive.
- If you are looking for quicker growth, consider small individual REITs since they grow faster than large REITs. However, they don’t possess similar cash flows or large economies of scale.
- Good track performance. Choose a real estate mutual fund that tracks the performance of the REITs they invest in and ensure that it allocates its capital appropriately.
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Conclusion
Individuals looking to diversify or considering alternative investment opportunities will find real estate mutual funds appealing because of their affordability and considerable returns. You can start investing with a mere $1,000. They are also an excellent way to include real estate assets as part of your investment portfolio.
That said, while real estate mutual funds make a worthwhile addition to a balanced portfolio, it’s crucial to understand your mutual fund’s underlying holdings. You also need to figure out whether they fit within your overall investment strategy.
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