Real Estate Mutual Funds

One of the ways the average investor can get started in the real estate market is through real estate mutual funds.   Many of these specialized mutual funds allow investors to gain entry into this market with as little as $1,000.  Real estate funds also offer the investor the advantages of a mutual fund.  This includes a portfolio with lower overall risk, as well as professional management of the fund.

Real Estate Investing

Anyone that owns a home is already investing in real estate.  Many of these same individuals are even using a leveraged position.  It's called having a mortgage.  For many individuals, their real estate investment strategy stops with their home.  Unfortunately, these same investors may be overlooking an opportunity to enjoy the rich benefits of the real estate mutual fund sector.

Three Ways to Invest in Real Estate

Let's step back for a moment to briefly review the three ways we're able to invest in real estate:

• Owning Real Estate - this strategy involves the investor selecting, and purchasing, individual real estate properties.  There are many experts that can help investors to get started in this area.  This particular strategy is beyond the scope of this publication, other than a introduction to the topic of flipping homes.
• Real Estate Investment Trusts - companies established as trusts that invest in real estate, mortgages, or a combination of each.  Real estate investment trusts are often referred to as REITs.
• Real Estate Mutual Funds - funds composed of real estate companies, businesses supplying services to the real estate market, and real estate investment trusts.

Let's first take a closer look at real estate investment trusts and real estate mutual funds.  Later on, we'll finish this article with a list of some of the best performing real estate mutual funds on the market.

Real Estate Investment Trusts

Real Estate Investment Trusts, or REITs, typically own and operate real estate properties.  These may include multifamily dwellings, shopping centers and malls, commercial office space, and even hotels.  Real estate investment trusts are run by a board of directors, which make the investment decisions on behalf of the trust.

REITs offer the investor several advantages such as diversification, liquidity, and professional property management services.  We've talked about this topic in more depth in our article on Real Estate Investment.

The earnings growth for these trusts can come from several sources.  For example, an increase in occupancy rates for hotels or commercial office space owned by the trust.  The trust can grow earnings by investing in additional properties, or by running existing properties more efficiently.  They can also invest additional capital into existing properties to improve their appearance and marketability.

REITs and Federal Income Taxes

The structure of a REIT was originally designed to provide individuals interested in investing in real estate with the same benefits that mutual funds provide to those interested in investing in stocks.  REITs can be both publicly or privately held companies.  Non-private (public) REITs can be listed on stock exchanges just like shares of common stock.

REITs themselves usually pay little or no federal income tax.  But they are subject to a number of requirements set forth by the Internal Revenue Service.   In particular, there is a requirement to annually distribute at least 90% of the REIT's taxable income in the form of dividends to its shareholders.

Many REITs distribute all of their current earnings.  In some instances, they often distribute more than current earnings.  If a REIT distributes more than its taxable income, the excess distribution is considered "return of capital."  This kind of distribution is taxed as a capital transaction rather than regular income.

The requirement to distribute earnings can have a negative effect on investors seeking to maximize the growth on their investment with REITs.  However, improvements in the REIT's underlying holdings such as leases, properties, or changes in interest rates continue to fuel the market's demand for real estate investment trusts.

Real Estate Mutual Fund Returns

The final alternative for individuals seeking to move some money into the real estate market is to invest in real estate mutual funds.  According to Morningstar's rating system, the mutual funds in this specialty area have enjoyed tremendous growth in the past ten years, with an average annual return of nearly 11% as of April 2011.

In fact, analysts often believe this long-term success means this run may be near an end.  However, these same analysts agree that real estate mutual funds play an important role in a long-term investment portfolio.

Real estate mutual funds tend to focus their investing strategy on real estate investment trusts and real estate companies.  Typically, this latter category would include large builders of real estate properties.  The returns of these mutual funds will usually be influenced by economic factors such as the matching of supply and demand for commercial office space as well as interest rates.

In the same way that interest rates affect the local real estate market, rising interest rates usually result in decreased demand for real estate and flat or declining housing prices.  This is true because an increase in interest rates means home buyers will qualify for smaller mortgages.  On a larger scale, rising interest rates can have a dramatic effect on new home sales.

Top Performing Real Estate Mutual Funds in 2011

As promised, we are going to close out this publication by looking at several of the top performing real estate mutual funds in 2011.  All of these funds performed very well, but just remember that reward does not come without risk.

That being said, here is a list of some of the best performing real estate mutual funds as of late April 2011.  Each of these funds beat their category average in the last three and five years:

• CGM Realty (CGMRX) - a large cap real estate mutual fund, this no-load mutual fund requires an initial investment of only $2,500.  Top holdings include Simon Property Group, SL Green Realty Corporation, and Host Hotels & Resorts.  The fund has approximately $1.8 billion in assets, and the average return over the last five years is 8.76%. 
• Neuberger Berman Real Estate (NBRFX) - a mid cap real estate mutual fund, this no-load mutual fund requires an initial investment of only $1,000.  Top holdings include Simon Properties, Boston Properties, and Public Storage.  The fund has approximately $337 million in assets, and the average return over the last five years is 5.45%.
• Fidelity Real Estate Income (FRIFX) - a mid blend real estate mutual fund, this no-load mutual fund requires an initial investment of only $2,500.  Top holdings include Fidelity Revere, Ventas, and MFA Financial.  The fund has approximately $1.6 billion in assets, and the average return over the last five years is 5.09%. 

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