Indirect real estate investing refers to putting money into real estate without directly owning physical property. The most common ways to invest in real estate indirectly include real estate investment trusts (REITs) and real estate mutual funds or private equity funds. Compared to directly owning rental properties, indirect real estate investing provides more liquidity, diversification, and lower capital requirements, but at the cost of lower potential returns. This article will explore the different methods of indirect real estate investment, their pros and cons, expected returns, and risks.
Real estate investment trusts (REITs) provide liquid, diversified real estate exposure
REITs are companies that own and operate income-producing real estate such as apartments, shopping malls, offices, hotels, warehouses, etc. They are structured similarly to mutual funds, allowing investors to easily gain exposure to a portfolio of real estate assets. As publicly traded securities, REITs provide much greater liquidity than directly owning property. They also enable small investors to invest in major commercial properties that would otherwise require huge amounts of capital. While direct real estate investing may offer higher returns through leverage and active management, REITs provide a more hands-off approach to real estate investment with solid long-term total returns.
Real estate mutual funds and private equity funds allow pooled investment
Beyond investing in individual REITs, investors can also purchase shares in a real estate mutual fund or private equity fund that invests in various REITs and/or physical properties. These provide instant diversification across different real estate sectors, geographies, risk levels, etc. However, there are additional management fees levied on top of the fees charged by the underlying investments. Investors need to analyze whether the added costs are justified by superior portfolio construction and oversight by the fund manager.
Lower potential returns but easier access than direct ownership
In exchange for greater diversification and liquidity, indirect real estate investments generally deliver lower returns compared to directly owning and managing rental properties. However, with direct ownership come many headaches like finding and managing tenants, unexpected maintenance and repairs, securing financing, etc. For investors without the time, skill or risk appetite for hands-on real estate investing, indirect methods provide an easier way to add real estate to their portfolio.
Understand the risks beyond market fluctuations
While indirect investing removes many of the operational risks of direct ownership, investors are still exposed to market risks in the real estate sector.Macroeconomic factors like interest rates, inflation, and employment all impact real estate prices. There are also risks specific to each investment vehicle, like declining occupancy rates for REIT-owned properties or excessive fees charged by certain funds. As with any investment, investors should research risks before committing capital.
In summary, indirect real estate investing through REITs, mutual funds, and private equity funds offers a more liquid, diversified way to gain exposure to the real estate asset class compared to direct physical property ownership. While direct real estate investing has the potential for higher returns, it also requires significant expertise and capital. For many investors, particularly those with limited time and resources,indirect real estate investment provides an appealing middle ground with moderate expected returns.