The real estate market has come a long way since the 2008 financial crisis. Investors looking to tap into this diverse segment of the U.S. economy have two affordable options for doing so: real estate investment trusts (REITs) and real estate mutual funds.
REITs and real estate mutual funds are both designed for investors who want to diversify into the real estate market without having to invest directly in physical property. Both investment vehicles are easy to acquire and provide a more liquid option than outright ownership of the real estate. At the same time, the asset classes differ in a few notable ways.
In this article, we will explore the differences between these two asset types.
operates as a corporation or trust that invests directly in real estate through outright ownership of physical property or through mortgages. Although REITs trade on a stock exchange, they aren’t bought and sold like traditional equities.
This category of property investment is broken down into three main types:
As the names imply, an equity REIT invests in and owns properties, while a mortgage REIT invests in mortgages. A hybrid REIT combines the two. Regardless of their structure, REITs can invest in both residential and commercial properties.
To qualify as a REIT, the corporation must have at least 100 shareholders, be managed by a board of directors, and pay at least 90% of its taxable income in the form of dividends annually.
Some of the leading REITs in 2019 include the Simon Property Group (SPG), Equity Residential (EQR), and Public Storage (PSA).
Check out the top real estate mutual funds here
Real Estate Mutual Funds
Mutual funds are professionally managed accounts of pooled capital that invest in stocks, bonds, and other asset classes. Real estate mutual funds may contain REITs and other real estate stocks. Like REITs, real estate mutual funds provide dividend income to investors as well as capital appreciation.
Real estate mutual funds offer many of the same benefits as REITs but are said to provide more diversification benefits and lower transaction costs. Since they are managed professionally, real estate mutual funds benefit from the knowledge and research of an entire firm.
Unlike REITs, mutual funds don’t trade like stocks. You can purchase them directly through investment companies or brokerages. Examples of leading real estate mutual funds include Vanguard Real Estate Index Fund (VGSIX), DFA Real Estate Securities Portfolio (DFREX), and Fidelity Real Estate Investment Fund (FRIFX).
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Risks to Consider
Although real estate prices have been rising for several years, the asset class remains extremely sensitive to things like monetary policy, labor force mobilization, and wages. If the real estate market falters, as it has done in the past, there’s very little to shield REITs or real estate mutual funds from the damage. Contrast that to the S&P 500 Index, where REITs are only one of 11 main sectors. In theory, proper diversification in the stock market could help shield your capital from oversized losses due to property downturns. At the same time, real estate is usually a proxy for the broader economy, so if this component goes down, expect other segments of the market to also suffer.
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Some investors take solace in the fact that the Federal Reserve is lowering interest rates again. Banks are already passing on the savings to their customers, and this has partly come in the form of lower mortgage rates. All is well, right?
Not quite. The Fed being forced to cut interest rates after a decade of ultra-loose monetary policy should raise alarm bells about the health of the U.S. economy. The interplay between monetary policy and the U.S. economy is a risk that investors should consider before investing in property – whether directly or indirectly through REITs and real estate mutual funds.
The Bottom Line
Investing in real estate doesn’t offer the same ‘guarantees’ it once did, especially in the aftermath of the 2008 financial crisis. Investors looking for exposure to this sector without overleveraging or sacrificing liquidity will find great potential in REITs and real estate mutual funds.
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