One of the most popular methods of investing in real estate is through real estate investment trusts, or REITs. As an asset class, REITs are popular, especially among income investors, because they generate high dividend yields. To receive a favorable tax classification, REITs are required to distribute at least 90% of their distributable cash flow to investors through dividends. This results in high yields across REITs, which are attractive to income investors in this low rate environment.
Fortunately, investors can gain exposure to REITs and real estate investing through mutual funds. A number of mutual funds invest in real estate and generate high dividend yields. Here are a few real estate-related mutual funds investors should consider for income.
Three High-Yield Real Estate Mutual Funds
The following mutual funds offer high dividend yields that beat the average stock market dividend yield and carry low expense ratios. In addition, they have outperformed the S&P 500 Index since the beginning of the year.
|Fund Symbol||Dividend Yield||Annual Expense Ratio||Morningstar Rating|
|Vanguard REIT Index Fund (VGSIX)||4%||0.26%||3/5 Stars|
|T. Rowe Price Real Estate Fund (TRREX)||2.40%||0.76%||4/5 Stars|
|Fidelity Real Estate Fund (FRESX)||2.40%||0.78%||4/5 Stars|
In typical fashion, the Vanguard REIT fund offers the advantage of very low expense ratios. This is why Vanguard has built a reputation for itself, for some of the lowest expense ratios in the industry. This fund also sports an attractive dividend yield near 4%.
The Fidelity and T. Rowe Price funds offer a lower dividend yield than the Vanguard fund, but they make up for this by investing in higher-growth REITs. Both funds carry a 4/5 Morningstar rating, and both have outperformed the broader markets this year. The Fidelity and T. Rowe Price funds have returned 4% each this year, while the S&P 500 Index is down 1% year to date.
Of course, there are pros and cons of each fund that investors should carefully consider before buying.
Consider Unique Risks
There are risks to investing in real estate more broadly that investors should know. First and foremost is interest rate risk. REITs and other real estate investments are highly sensitive to changes in interest rates. REITs utilize debt to purchase properties, which then are rented out to collect income. When interest rates rise, it increases their cost of capital. This typically causes interest expense to rise, negatively impacting profitability. The Federal Reserve has signaled its intention to raise interest rates – although it has not yet raised rates, and there is some debate as to whether the Federal Reserve will raise rates this year at all. If the central bank delays further, it likely would be a positive catalyst for REITs.
Even if the Federal Reserve does raise rates, it likely will be a small increase – to 25 basis points. From there, it also is likely the Federal Reserve will take a cautious approach and raise rates slowly over time, so as not to endanger the economic recovery in the United States. As a result, it is likely the above-average dividend yields offered by REITs will still be attractive to income investors, even if interest rates rise slightly this year.
Real estate investment trusts make money by purchasing properties then leasing them to tenants. REITs can specialize in a wide variety of industry focuses, including retail, healthcare or technology. Investors like REIT funds because they pay very high dividend yields, and many offer low expense ratios.
Interest rates remain near historic lows, as the U.S. Federal Reserve continues to delay raising interest rates. Interest rates have not been increased in a decade. This has resulted in very low yields across most asset classes. However, real estate investment trusts offer high yields, which are very strong yields in today’s investing climate.
Furthermore, these yields are attractive, whether rates rise this year or not. As a result, income investors who are starved for yield should consider diversifying their portfolios to include some REIT mutual funds.
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