Investing in Real Estate Without Buying Property
Investing in real estate can be very lucrative, but getting started in real estate investments requires a large amount of capital.
That being said, if you do not have hundreds of thousands of dollars on hand, there are other options to invest in real estate without buying a physical property. (See also: What Are the Differences Between Investing in Real Estate and Stocks?)
Invest in a REIT
A REIT, or real estate investment trust, is a company that owns and manages real estate and related assets, such as mortgages or mortgage bonds. The majority of a REIT's income and assets must be linked to real estate. To qualify as a REIT, companies must meet these standards, plus additional rules defined by the Securities and Exchange Commission:
- Invest at least 75% of total assets in real estate assets
- Derive at least 75% of gross income from property rent or mortgage interest
- Have a minimum of 100 shareholders after its first year as a REIT
- Have no more than 50% of shares held by five or fewer individuals
- Pay at least 90% of taxable income as shareholder dividends
That last rule is significant for individual investors. REITs are not simply companies that own real estate; they are businesses that provide cash flow to their investors. If you invest in a REIT with dividend reinvestment, you can grow your portfolio until you reach a point where you can purchase individual properties yourself, or continue to invest in managed real estate portfolios. (See also: 5 Types of REITs and How to Invest in Them.)
Invest in a Real Estate Focused Company
Many companies that own and manage real estate are not structured as a REIT. The stocks of these companies typically pay a much lower dividend than a REIT, but the businesses have more freedom to reinvest profits to expand.
Some companies in other industries behave like a real estate company even though that is not the primary service they offer. Examples include hotel chains, resort operators, and shopping mall and strip mall managers.
Of course, there are traditional real estate companies available for investments as well. Companies include real estate services companies like RE/MAX Holdings Inc. (RMAX), commercial real estate operators like CBRE Group (CBG) and shopping center companies like Equity One (EQY).
As with any individual stock investment, always do plenty of research before making an investment decision. Investing heavily in one stock or industry relative to the rest of your portfolio opens you up to portfolio concentration risk.
Invest in Home Construction
Real estate is not just about buying and profiting from existing companies. There is an entire industry of homebuilders responsible for developing new neighborhoods in growing metropolitan areas. These companies may be involved with multiple aspects of the home construction process.
When evaluating homebuilders, look at all aspects of the business. Ask yourself if the company is focused on a region with poor real estate performance if the company is focused on only very high- or low-end homes, and compare the focus to real estate trends.
Keep in mind that homebuilder performance can be highly correlated to the economy. When job growth is strong, people want to buy new homes. When the economy is sluggish, new home sales tend to fall.
Invest in a Real Estate Mutual Fund
One of the most difficult hurdles in real estate investing is diversification. As a retail investor in the stock market, it is not difficult to find a wide range investments. Shares of many companies trade at a low enough price that achieving a diversified portfolio can be reached at a reasonable price point through planning. Real estate is quite a bit different. In real estate, a single asset typically costs well into the six-figure range. Only one company, Berkshire Hathaway Inc. (BRK.A) trades at that level. Few stocks reach high into the four-figure level.
To get diversification in real estate, investors can turn to real estate focused mutual funds, index funds, and ETFs. Some real estate funds work just like a traditional mutual fund, primarily invested in real estate stock. Others are focused on REITs or even direct purchases of real estate.
An example of a popular REIT ETF is the Vanguard REIT ETF (VNQ). This ETF trades just like a stock but gives you instant exposure to a portfolio of REITs. This fund holds 145 different stocks. Top holdings include Simon Property Group Inc. (SPG) and Public Storage (PSA).
If you prefer a real estate mutual fund, Prudential Global Real Estate Fund (PURAX) is a global real estate fund. The fund is 97.5% invested in real estate: 52% of holdings are in North America, with the remainder invested in Europe (17%) and Asia (31%). This fund is primarily focused on developed markets, with less than 2% of funds invested in emerging markets.
The Bottom Line
Investing in individual properties requires a lot of capital and comes with a high risk. Investing in other options available through the stock market -- REITs, mutual funds and ETFs -- can give your portfolio real estate exposure without having to lay out hundreds of thousands of dollars. As with any investment, investing in real estate and related companies comes with some risk. Evaluate any investment option before buying to ensure it lines up with your investment goals.
American and global real estate has performed well in recent years, but not all markets are alike. Some real estate exposure provides an excellent hedge against other market fluctuations, but too much real estate concentration leaves you open to losses when the real estate market falters, as it did with the recent years with the real estate bubble and mortgage crisis.
However, once you have a good understanding of your investment goals and how real estate can play a part, you can confidently invest and make real estate a portion of your portfolio for both short-term and long-term investment goals.