Since the housing market peak in 2005, investing in real estate has been fraught with peril, to say the least. The commercial and residential real estate industries have struggled since, but as any contrarian will tell you, market downturns can offer appealing opportunities to pick up investments on the cheap. (For more, check out 10 Habits Of Highly Effective Real Estate Investors.)
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The good thing for smaller or individual investors is that there is no need to buy individual properties. A number of alternatives exist that offer more liquid and diversified investment options. In other words, don't worry about having to take out a $250,000 loan or whether your credit score is high enough to garner a favorable interest rate. Here are some options to get you started in real estate for a fraction of what it would cost to buy an actual property.
Real Estate Investment Trust (REIT)
A real estate investment trust (REIT) represents one of the easiest ways for individual investors to gain exposure to real estate assets. A REIT is simply a security that invests in a basket of real estate assets or related securities such as mortgages or mortgage-backed securities (MBS).
There is a dizzying array of REIT investment out there for investors to choose from. For instance, certain REITs specialize in commercial real estate, such as Realty Income Corp (NYSE:O), shopping malls, such as Simon Property Group (NYSE:SPG), or even amusement parks, such as Cedar Fair (NYSE:FUN), though the latter officially trades as a limited partnership and has some different investment implications.
Another important consideration with REITs is that they must pay out 90% of their taxable profits as distributions. This allows them to avoid corporate income taxes and also means that investors tend to rely on REITs for what can be a generous yield.
It is also worth pointing out that since these firms must pay out most of their income to shareholders and need to invest in expensive real estate, they can have significant debt on the balance sheet. This is generally not a concern in normal economic conditions and revenue from rent received on their properties usually far exceeds debt-servicing costs, but it does mean that they can be hit during downturns in the economy. As with most industries, leverage is a double-edged sword.
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Real Estate Funds
Investing in REITs may be especially appealing for stock pickers and those interested in bottom-up security selection. Others may find real estate funds more suitable. For starters, they are more diversified and lessen the likelihood that an individual firm will torpedo overall returns. They can also allow for more broad exposure across geographies, such as across the U.S. or even internationally, and can also spread bets across property types, be it commercial, residential or by industry.
Two funds that have performed well recently are the JPMorgan U.S. Real Estate Fund (SUSIX) and T. Rowe Price Real Estate Fund (TRREX). Ken Heebner's CGM Realty Fund (CGMRX) bridges the gap between individual REIT and diversified fund approaches due to its more concentrated investment philosophy.
Additionally, more traditional bond funds can also invest exclusively in real estate assets. The Fidelity GNMA Fund (FGMNX) invests primarily in mortgages backed by the Government National Mortgage Association, which is also known as Ginnie Mae. The fund has a current yield of 2.78% and has garnered mid-single digit annual returns for investors over the past decade.
By definition, private equity (PE) is equity capital that does not trade on a public exchange. In essence, companies can either be public or private, but they are still companies that have operations and earn returns for shareholders.
Private equity investors generally specialize in managing pools of private companies. The line between the public and private realm is somewhat blurred as PE firms frequently buy public companies at a hefty premium and take them private. As with REITs, this can involve significant amounts of debt and needs to be taken into consideration when investing in the space.
Investing in a true PE fund is usually reserved for wealthy individuals and large institutions that are supposedly more sophisticated investors and have the ability to handle what is a very illiquid asset class. However, in recent years a number of PE firms have gone public, which means that retail investors can gain exposure to the space with very low investment amounts. Two firms in this space are Kohlberg Kravis & Roberts (NYSE:KKR) and The Blackstone Group (NYSE:BX). (To learn more, see Private Equity Opens Up For The Little Investor.)
As with any investment, further due diligence is needed to determine if it meets your individual circumstances or if the investment is a decent value at current prices. You may also find better individual options in the general categories above. The overall takeaway is that there are many liquid, straightforward ways to play the real estate markets these days. Finally, down markets mean there are many potential deals out there, and real estate is generally a solid investment option during periods of high inflation.
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