Having an asset within your portfolio that yields passive income while also providing a hedge against inflation is an attractive dual feature for many investors. A commercial real estate investment fund (CRE) can be an excellent addition to one’s portfolio. The benefits of a CRE include portfolio diversification, liquidity, and the fact that investors will save time not having to manage a property.
What Is a Commercial Real Estate Investment Fund?
Generally speaking, a CRE is any investment that pools capital from investors with the intent to deploy it into commercial real estate properties. Though there is certainly nuance between the specifics of one fund and another, they typically have a few things in common.CREs have fund managers who ultimately make the decisions regarding the fund and where the money goes. When real estate investors invest their money into a fund, they do not know what properties the money will be used to purchase. Trust is placed in the fund manager to seek out the best opportunities.
The diversification that CREs provides is one of the most attractive qualities. Invested capital is spread among several properties; the type of property, location, and type of tenants are all facets that add to the diversification. Overall, this type of diversification helps to reduce the risk to investors.
These types of funds tend to provide a higher availability of liquidity, with some funds being able to be bought and sold like stocks, providing a type of short-term liquidity not often found in commercial real estate investments.
Most CRE funds pay healthy dividends derived from income produced via the tenant’s rent for the fund’s properties. This is the passive income many investors seek when investing in CREs.
The Different Types of Commercial Real Estate Investment Funds
There are four types of commercial real estate investment funds: real estate investment trusts (REITs), exchange-traded funds (ETFs), mutual funds, and private equity funds.Real estate investment trusts: A REIT is a type of commercial real estate investment marked by its often high dividend yield and favorable tax advantages. The lion’s share of a REIT’s income must come from real estate, and 90 percent of its taxable income must be paid out to investors if the trust wants to preserve its tax-advantaged status. The tax advantage of REITs is that they are not taxed on the corporate level, as individual unit holders pay taxes.
REITs can either be privately held and only accessible to accredited investors or publicly traded, meaning that their shares can be bought and sold in the stock market. REITs typically specialize in niche property types, such as office buildings or multifamily apartment buildings.
Exchange-traded funds: An ETF is quite similar to a mutual fund, although some key differences exist. ETFs are mutual funds traded on major stock exchanges, making them easier to buy and sell. They typically come with lower management and custodial fees.
Mutual funds: While REITs directly invest in properties, a mutual fund invests in the equity security of the companies that invest in the properties. Mutual funds are not required to pay out a high percentage of their taxable income as dividends because they typically are offered from their management companies directly to the investor.
Investors with moderate risk tolerance seeking passive income and capital appreciation tend to find mutual funds to be a good fit.
Private equity funds: These types of funds pool their investors’ capital in the equity portion of commercial real estate deals. They are held privately, are available only to accredited investors, and tend to be less liquid. This is because these funds cater to investors seeking investments with longer horizons. These funds often require a five- to 10-year commitment.
Given the investment horizon and accreditation barrier, these private equity funds are usually only available to wealthy investors.
Benefits to Commercial Real Estate Funds
Though there are several different types of funds, they are all somewhat similar and tend to offer the same benefits and carry the same risks as well. Like any investment, there are pros and cons to consider before parting ways with your money.Diversification and liquidity: Two of the most attractive benefits of these funds are their diversification and their liquidity. Because capital is spread among different locations, properties, and types of tenants, investors stand to benefit from a diversified portfolio all within a single share of funds. Publicly traded funds have the advantage of being able to be bought and sold easily, which is an attractive attribute for investors in need of liquidity.
Hands-off investment: Since the fund is managed by someone else, investors benefit from the manager’s experience and don’t bear the responsibility when selecting what assets to invest in. This expertise is an added benefit, as fund managers can use their own professional networks to gain access to deals otherwise unavailable to the average investor. Since the fund manager does all of the heavy lifting, fund investors get the benefit of real estate ownership without the bother of actually having to manage any properties. This will free up substantial time for investors to follow other investments or pursuits.
The Risks
Though there are significant benefits to investing in CREs, they must be weighed against the risks associated with the fund.Lack of control: Though the hands-off and responsibility-free nature of these real estate fund investments may be attractive to some, investors have no control or say regarding how their money is used. This can be a deterrent for some investors. Fund investors also have no say in the day-to-day decisions regarding property management and must play a passive role regarding when and if the property will be sold.
Time commitments: Most private equity funds and many REITs require notable time commitments. This can be off-putting for some investors, particularly if they require liquidity, because they may not be able to access their capital for five to 10 years. Longer investment horizons can expose investors to more market risks, leading to increased volatility.
Fees: Fund managers do not work for free. Though most publicly traded REITs and ETFs have low management and custodial fees, the same cannot be said for some mutual funds and private equity funds. These types of investments tend to have higher fees, which will certainly impact overall returns.
How to Invest in Commercial Real Estate Funds
Investing in publicly traded REITs and ETFs is a straightforward process. After doing their research, an investor simply needs to decide how much money they want to invest, identify the ticker symbol for the ETF or REIT, and then place the trade via their brokerage account. Trade requests typically are handled swiftly and, depending upon an investor’s brokerage account, there may be a small commission fee. However, this fee is low compared to the fees associated with mutual funds, private REITs, or private equity funds.The process isn’t quite as straightforward, however, for privately traded investments in private equity funds and REITs due to the fact that their respective firms are responsible for verifying that their investors meet the appropriate accreditation requirements. Since this often involves reviewing bank statements and tax returns, this can take more time. Since these investments are not publicly traded, the firm will typically provide regular updates on the share price or investment value.
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