As far as taking exposure in real estate is concerned, stock and fund investors are usually keen to diversify their portfolios with real state sector focused funds. Real estate has a long history of outperforming inflation and that very reason makes it a sound alternate investment.
The risks are similar to that of individual stocks, and investors can lose big time for different reasons. While those risks don’t turn away enthusiastic investors, it’s really important to be aware of risks and rewards before making investment commitments.
This write-up will examine such inherent risks and rewards of investing in real estate funds and ETFs.
What exactly a real estate fund is all about?
It can be any professionally managed fund that focuses on diversified holdings across real estate market including rental properties, commercial real estate, industrial properties and retail. Such funds have the option to buy out the holdings directly, and they can even do so through real estate investment trusts (REITs).
These funds can have investments both overseas and in the domestic market. What does the historical performance suggest about returns from real estate fund investments? Performance of funds for the likes of REITs and real estate ETFs largely depends on the overall performance of the economy. They grow in value during the times of high growth and inflation, and usually lose steam when an economy dips into recession.
For instance, we saw tremendous growth in returns from such investments from early 90s till 2005 and then there were heavy outflows that took a nasty shape in 2008 and 2009.
Why Should Small Investors Take Exposure In Real Estate Funds?
A small investor cannot possibly make a direct purchase of large commercial properties where the potential of generating returns is always higher than residential properties. Real estate funds enable small investors to participate in such areas of growth; moreover, such funds are professionally managed and well diversified.
The Key Risks and Rewards Investors Must Know
In case of REITs, investors are paid 90 percent of after tax income as dividends, which make them a highly lucrative option for income investors.
These funds offer you diversification within the sector, as they invest in different type of properties, which may perform differently in any given environment.
Ideally, real estate funds are focused on growth as well as income. These have generally benefited from special tax treatment, so tax conscious investors must have them as a part of their portfolio.
Real estate funds can be much more volatile than funds with diversified exposure and investors should be prepared to see considerable value depreciation in the short term.
The performance of these funds is also linked to the liquidity in the market and the interest rate fluctuations. Both these factors can dramatically appreciate as well as depreciate the value of a fund.
Income oriented funds are highly susceptible to low occupancy especially when they have a high exposure to commercial properties.
The real estate market is an excellent alternative for investors who want to diversify their portfolio out of stock and bond investments. Investors can slowly build their real estate exposure using ETFs. This allows them to take advantage of large-scale opportunities with small amount of cash inflows. However, given the volatile nature of such fund investments, one should consider staying invested over the long term and reap benefits of solid dividend income.