Real estate funds are a type of mutual fund that invests in real estate properties. These funds are managed by a fund manager and portfolio holdings tend to include domestic or foreign commercial, corporate, or rental properties and can include residential properties. REITs, or real estate investment trusts, are managed by a board of directors and involved in the ownership and operation of real estate properties. An investor purchasing a share of the REIT is investing in the trust’s pool of real estate assets. REIT assets generate income, which must be distributed regularly to investors.
Advantages of a Real Estate Fund
Real estate funds invest in a broader asset selection than a REIT, making investment in this sector feasible for a small investor with limited capital. These funds invest directly in properties and can also hold REITs within their portfolio providing greater diversification. The performance of these funds tends to mirror the general economy, posting strong returns during inflationary and growth periods and posting low returns during recessionary periods. If appreciated properties held by the fund for more than one year are sold, the investor will earn capital gains that are subject to lower tax rates.
Disadvantages of a Real Estate Fund
Investment in real estate funds requires a long-term commitment since growth in real estate returns tends to grow gradually. The real estate sector is also subject to volatility, and a slumping real estate market can take years to recover. This type of fund is affected by various types of risk related to liquidity, market and interest rates. The asset’s liquidity or ease of conversion to cash is affected by the property’s value and the market demand for the property at that value. Market and interest rate risk will affect the fund’s volatility and overall returns.
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Advantages of a REIT
One of the main advantages of investing in a REIT is the investor’s gain from the asset’s potential for appreciation in value and its income-generating properties. REITs are required to distribute up to 90 percent of their taxable income to avoid taxation, which can provide a higher and more frequent income stream than dividend-paying stocks.
Disadvantages of a REIT
Choosing the right REIT can require substantial research on the fund’s holdings and the board’s track record on profitability and property appreciation. Capital requirements for investment can be higher than for a real estate fund but lower than the amount required for direct investment in a group of properties. The distribution of up to 90 percent of income to avoid federal taxation can also limit the trust’s growth prospects and is subject to the investor’s ordinary higher tax rates.
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