Add Some Real Estate to Your Portfolio

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Add Some Real Estate to Your Portfolio

Real estate has lately seen consistent growth as it has solidified its place in institutional and individual investors’ capital asset allocation matrices. Institutions seeking effective asset management are progressively switching to specialist real estate funds of funds because to the capital-intensive nature of real estate investment, its necessity for active management, and the growth in global real estate prospects.

Similar benefits also apply to retail investors, who have access to a considerably wider range of real estate mutual funds than in the past, enabling effective capital allocation and diversification.

Real estate offers advantages and disadvantages, just like any other financial field. However, for the majority of investment portfolios, it should be taken into account, with real estate investment trusts (REITs) and real estate mutual funds being seen as perhaps the best ways to fulfil that allocation.

Key Takeaways

  • Real estate investment trusts (REITs) and real estate mutual funds are good options for a diversified investment portfolio for both retail and institutional investors.
  • Real estate investment trusts (REITs) often own and manage buildings including homes, shops, malls, offices, and hotels.
  • With very little cash, real estate mutual funds, which invest largely in REITs and real estate operating firms, may provide diversified exposure to the real estate market.
  • Many novice investors are unaware that simply owning a house, they may already be directly investing in real estate.

Barriers to Real Estate Investing

Large participants like pension funds, insurance corporations, and other significant financial organizations have traditionally dominated the real estate investment market. There is now a tendency toward real estate holding a permanent position in institutional portfolio allocations as a result of the globalization of real estate investment and the advent of new offshore options that provide for a better degree of diversity as well as return potential.

Permanent real estate capital allocation presents some special challenges. It is first and foremost very capital demanding. Commercial real estate investments often need large quantities of money up front, unlike equities that may be bought in modest amounts. Direct investing in real estate sometimes leads to lumpy or illiquid portfolios and idiosyncratic risks depending on location or property type.

Additionally, active administration and upkeep of real estate are expensive and labor-intensive. A real estate allocation takes more thought and resources to manage than standard investments do.

Institutions often favor real estate funds and funds of funds as a consequence of these problems. Retail investors may get these same benefits by using REITs. Even while individual REITs often hold many properties, REIT exchange-traded funds (ETFs) and real estate mutual funds that each invest in various REITs now provide for even more diversification.

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Real estate assets are now readily included into portfolios by even small investors. Here are a few options for retail investors to have exposure to real estate and leverage its return potential.

Direct Investment

This tactic involves picking out certain properties and buying them outright as investments. These often consist of rental income-producing assets that also benefit from market value gains.

Control is a key benefit of this approach. Direct property ownership enables strategy creation and execution as well as direct control over return. However, direct investing makes it exceedingly difficult to put up a real estate portfolio that is well-diversified. It also entails becoming a landlord, with all the associated expenses, dangers, and management difficulties.

The real estate allocation for the majority of retail investors is too little to enable the acquisition of sufficient properties for meaningful diversification. Additionally, it exposes more people to dangers related to real estate and the local real estate market.

Homeownership

Many retail investors who haven’t thought about include real estate in their investment portfolios don’t know that simply owning a house, they may already be investing in real estate. In addition to already having exposure to real estate, most of them are also accepting extra financial risks by holding a mortgage. Most of the time, this exposure has been advantageous, assisting people in accumulating the cash needed for retirement.

Real Estate Investment Trusts (REITs)

The private and public equity stock of businesses that are set up as trusts and make investments in real estate, mortgages, or other real estate collateralized assets is represented by REIT shares. Real estate properties are often owned and managed by REITs. These could include apartment complexes, shopping centers with supermarkets as anchors, small-town shops and strip malls, malls, office buildings, and hotels.

A board of directors oversees REIT operations and decides the trust’s investment strategy. If they give out 90% of their taxable profits as dividends to shareholders, REITs pay little to no federal income tax. Despite the fact that the tax benefit boosts after-tax cash flows, REITs’ incapacity to hold onto capital may seriously impede growth and long-term value. In addition to the tax benefit, REITs provide many of the same benefits and drawbacks as stocks.

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The strategic direction, investment, and property choices made by REIT managers help investors with management-related concerns. The difficulty of investing with low cash and the substantial amount of asset-specific knowledge and research needed to choose them and estimate their success are REITs’ biggest drawbacks for retail investors.

Compared to real estate investments, REIT investments have a far stronger link to the entire stock market, which causes some to undervalue their diversification benefits. In comparison to direct real estate, the REIT market has seen more volatility. This is because REIT stock prices are driven by macroeconomic factors, while direct real estate is more affected by local real estate markets and evaluated using the appraisal process, which tends to smooth investment returns.

Real estate funds enable investors to take advantage of the income and long-term development possibilities of real estate even if they lack the desire, expertise, or resources to purchase land or property on their own.

Real Estate Mutual Funds

Using experienced portfolio managers and thorough research, real estate mutual funds themselves invest mostly in REITs and real estate operating businesses. They enable the acquisition of diverse real estate exposure with just a modest outlay of cash. They provide investors a far wider range of assets than can be obtained by purchasing REIT stocks alone, depending on their strategy and diversification objectives, and they also give investors the option of readily switching from one fund to another.

Flexibility is also beneficial to mutual fund investors since it is easier and less costly to buy and sell assets via a structured exchange than through direct investment, which is time-consuming and expensive. To enhance profit, more speculative investors might strategically overweight a particular property or area exposure.

Comparatively to purchasing individual REIT equities, broadening exposure to mutual funds may also lower transaction costs and charges. The analytical and research data on purchased properties offered by the funds, together with management’s viewpoint on the feasibility and performance of real estate as both a particular investment and an asset class, are important benefits for retail investors.

However, compared to REITs or REIT ETFs, mutual funds could be less liquid and have greater management costs. Although real estate mutual funds provide liquidity in a historically illiquid asset market, detractors contend that they fall short of direct real estate investing.

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Do all real estate investment trusts (REITs) pay dividends?

Yes, according to federal law, a business must pay at least 90% of its taxable profits as dividends to shareholders in order to qualify as a real estate management (REIT).

Do I have to pay taxes on rental income?

Yes, if you are a landlord, you must report and pay taxes on your rental income. Keep in mind that rental income is often seen as passive income. You may be able to deduct property-related costs from your rental revenue, such as utility bills, maintenance, and insurance.

How much of my portfolio should I allocate to real estate?

The majority of experts agree that for many investors, owning some real estate (direct or indirect) is a smart idea. Your risk tolerance, time horizon, liquidity requirements, and other real estate assets are a few examples of the variables that will affect how much of your finances you allocate to real estate. If you currently own a house, for instance, real estate may really make up a sizable portion of your total worth. Additionally, if you work in a sector that is tied to real estate, the real estate market already affects your income and job prospects. Advisors often advise allocating 5% to 20% of a portfolio to real estate (with differences in opinion on whether to include your home equity).

The Bottom Line

Retail investors can and may consider homeownership when allocating their portfolios, but they may also take into consideration other, more liquid real estate assets.

REIT investment offers access to some of the advantages of real estate investing without the requirement for direct ownership for people with the necessary trading abilities and resources. Real estate mutual funds would be a good option for individuals who are contemplating a lower contribution or for those who don’t want to be burdened with asset selection but need optimum diversity.

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