If your investment club is looking to diversify, looking into a real estate investment trust (REIT) is one way to invest in the real estate market without physically purchasing property. REITs own and manage portfolios of real estate properties and mortgages. They trade on public exchanges the same way most stocks do. In short, you can get the benefit of owning real estate even if you don’t have the money or time to purchase property.
However, instead of purchasing a single REIT, financial adviser Chris Long recommends putting your eggs in several baskets with an index fund. “It’s very difficult to predict which individual REITs are going to perform well over the long run,” says Long. “A lot of REIT funds tend to underperform the index significantly. Just as a lot of stocks tend to underperform.”
Long offers three key pieces of advice for researching a REIT index fund for your investment club:
Evaluate costs: One of the advantages of investing in an index fund versus a mutual fund is lower fees. Because index funds are not actively managed–the way mutual funds are–there is a lower management expense ratio. “Within a category of funds, the single biggest determinant of performance is expense ratio,” says Long. The higher the expense ratio, the better the fund must do to maximize an investor’s return. Long recommends finding a fund with an expense ratio under .5%.
Understand the types of REIT funds: Some REIT funds base their return on the rental income from the properties it invests in. “Those tend to be a little more stable, in a sense, because they’re a little less speculative,” says Long. Other funds invest in properties that look to be undervalued. These funds operate on a buy and hold strategy. The profit comes from selling the fund. Says Long, “That’s a more speculative fund.”
Evaluate your club’s risk tolerance – Just as with the housing market, REITs tend to be volatile. For example, Long says the Vanguard REIT index fund had its worst year in 2008, dipping 37%. Last year, it experienced a 30% rise because real estate prices began to pick up. Understand that investing in a REIT index fund is just like general investing: If you club is looking for consistent long-term performance, it’s important to look over the five to 10 year history of the fund, says Long. Before your team invests, make sure you investment goals as stated in the club’s contract are aligned with the index fund.