Should You Add a Real Estate Mutual Fund to Your Portfolio

Real Estate provides very good investment diversification to a portfolio. There is not much correlation between the real estate market and the stock market. In other words, these two investments do not move together. Best of all, real estate funds have outperformed the stock market over the long term with the same level of risk.

Almost every investment portfolio should have exposure to real estate. Many investors may feel that their home is their largest investment and, therefore, further real estate investing is unwise. However, for most investors, their houses are there homes. If a person sells a house, they normally buy another house. In this instance, the house is not an investment which will be used to fund retirement. The amount of an overall portfolio that should be invested in real estate is between 10% to 15% of assets.

Real Estate Mutual Funds and REITS

Real Estate Mutual Funds offer a simple and efficient means of gaining exposure to the real estate market. These funds invest in companies that are in the real estate business or own large amounts of real estate. Such companies would include construction companies and building supply firms. Many of the mutual funds will invest all or a portion of their assets in equity or mortgage REITS.

REITS are Real Estate Investment Trusts. These trade similar to stocks, and normally specialize in either equity or mortgage investments. Equity REITS own and operate the real estate. Mortgage REITS create and trade mortgages. Equity REITS tend to have greater capital gain potential with lower yields. Mortgage REITS tend to have higher yields, but lower capital gain potential.

Many mutual funds invest in REITS to gain the desired level of equity or mortgage real estate exposure. The type of real estate selected will affect the overall level of return of the mutual fund.

The reason to invest in a mutual fund rather than directly in the REIT is that the mutual fund has a professional manager who understands the real estate market and the REITS. Investing directly in the REITS leaves the decision up to the investor.

Understand Your Real Estate Mutual Fund

As with any investment, the investor must research and understand the objective of the mutual fund. This includes past history of the fund’s investment in either type of REIT or directly into real estate companies. Is the fund tilted toward equity or mortgage real estate investments? Has the fund been consistent with its approach?

The fund prospectus will provide most of the needed material to understand how the fund manager approaches the real estate market. However, it may be difficult with some funds to ascertain exactly the investment style of the manager. The fund prospectus will outline what the manager is empowered to do, but these powers may be very broad and, therefore, not very helpful.

There is much review material on the internet about most of the funds. If the prospectus is not clear enough, do a search to find fund reviews and comparisons. It will soon become clear how the fund has been managed and how it has performed relative to other real estate funds.

Investors also need to realize that investing in real estate should be a long term objective. These funds should not be used for short term trading. Even though real estate funds have not performed well for several years, they still have the potential to outperform stocks over the long term.