What is a Real Estate Investment Fund?
In 2023, the Social Security Administration calculated the cost-of-living adjustment (COLA) at 8.3%. The purpose of the COLA is to ensure that Americans receiving social security can continue affording their basic necessities even with inflation.
The 2023 COLA represented the largest increase since 1981. As inflation gets worse, your cash assets become less valuable. On the other hand, investments help to protect the value of your money as the cost of living continues to surge.
Now is an especially opportune time to invest in real estate. If you want the benefits of real estate investment without the work of flipping houses or becoming a landlord, a real estate investment fund might be the right choice for your portfolio.
Some Background: Understanding Mutual Funds
A real estate investment fund is a type of mutual fund. A mutual fund pools money from multiple investors to invest in several different securities. You and several other investors give your money to the fund. The fund then chooses which securities to invest in with your money. When the securities pay out dividends or returns, the fund makes money. Then, the fund pays that back out to its investors based on their share. Funds can also make money by selling some of their securities for a higher price than they bought them for, and you, as the investor, can make money by selling off your share for more than you bought it.
Advantages of Mutual Funds
There are numerous advantages to investing via a mutual fund. First, it comes with built-in diversification. Funds don’t put all their money into one security and instead choose several different investments. Diversification is the best way to maximize your returns and mitigate risk. However, this can be a challenge if you are not an investing professional. Not only will you have to pay the full investing expense for every security you invest in, but you will also have to build a balanced portfolio on your own.
Mutual funds are managed by professionals. They have the tools and experience to analyze all possible investments and select a portfolio that will likely offer the best returns. You will also share the transaction cost with other members of the fund, reducing how much you have to spend to invest.
How does a Real Estate Investment Fund Work?
A real estate fund is a mutual fund where all the securities are properties. The real estate mutual fund will invest in properties directly or indirectly. They may own individual properties that they collect rent from, build properties to sell to another owner or manager, or renovate and resell existing properties. In these cases, the money investors put into the fund will cover the cost of construction or upkeep. When the real estate fund collects rent or sells the property, it increases the fund’s value. That value returns to investors as dividends or when they cash out and sell their shares.
Other real estate funds may invest money into real estate investment trusts (REITs), real estate debt, or other real estate derivatives. These funds increase in value when the security pays out dividends. Those returns eventually go back to the real estate investors who own shares in the fund. A real estate fund might have several different assets of the same type, or they might have a few investments in each category.
At Arabella Capital, our investments fund multifamily, community development, mixed-use, and self-storage properties. Since we are the fund manager and the developer, we are able to share our development fees and investors start to receive quarterly distributions as early as the same quarter that they invest in the fund. On top of that, the capital you invest is expected to receive a 25% internal rate of return (IRR) by the time you exit in year 4.
Different Types of Real Estate Investment Funds
Even if you’ve decided that you definitely want to invest in a real estate fund, you’ll want to do some research to find the right investment fund for you. You’ll want to look at the types of properties and securities into which the fund invests your money, whether it is an open-end or closed-end fund, and whether the fund is passively or actively managed.
Open-End vs. Closed-End
An open-end fund gives you more flexibility to buy into the real estate fund or cash out of it whenever you would like. Open-ended funds are usually not limited in the number of shares they can issue. That means anyone with the money to do so can join and leave the fund whenever they want as long as it remains active.
Closed-end funds offer more limited opportunities to join. You will usually have a short time frame in which to buy shares. Closed funds may also have a limited number of shares available. Once you have bought your share, you are locked into the investment until it’s run through its natural life cycle.
For example, say you are buying into a fund that is building a new property. You may not be able to exit the fund until the property is completed and sold.
Actively Managed vs. Passively Managed
Actively Managed Fund
If you invest in an actively managed fund, the fund will take a very hands-on role in managing your investment. Active investing aims to beat the market. Fund managers will analyze the market to determine which assets are trending upward, purchase those, and then sell them when they are at their peak value. This can generate higher returns quickly but may also carry more risk.
Passively Managed Fund
Passively managed funds work on the principle that slow and steady wins the race. Growth takes longer but is more sustained and often generates higher returns in the long run. Instead of outperforming the market, passively managed funds try to mimic the underlying asset’s value. The assumption is that the assets will become more valuable as time goes on.
Is a Real Estate Fund the Same Thing As a REIT?
If you’ve just started to look into real estate investing, you may have come across the term REIT, or real estate investment trust. They are a type of real estate investment, but they are not the same as a real estate investment fund. In fact, you might remember that we mentioned earlier in this article that some real estate funds may invest directly in real estate investment trusts.
Here are some major key differences here: first, investing in an REIT is less like joining a mutual fund and more like buying a single security. The REIT is a corporation that directly invests in income-generating real estate. As an investor, you essentially buy stock in that corporation. As the REIT collects rent and fees from its properties, the value of your stock increases.
Arabella Capital pays out dividends to our investors, but not all real estate funds do. If you invest in one that does not, the only way to make money is to sell your share when the real estate market is at its peak, if it is an open-end fund, or wait for a closed-end fund to complete its natural lifecycle.
By law, REITs must pay out 90% of their taxable incomes to their investors as dividends, usually monthly or quarterly. This means that you will generate money much more quickly from your REIT. You will also get some of the benefits of direct ownership without actually owning the property.
REITs can invest in a broad range of holdings or have a narrower focus. If you are looking for a real estate investment that will easily add a lot of diversity to your portfolio, you’ll want to research REITs thoroughly to understand how diverse their holdings are.
Benefits of Investing in a Real Estate Fund
Real estate is considered a fantastic investment for any portfolio, especially if you’re looking to diversify. Real estate investment funds are particularly attractive if you want to maximize your benefits while taking advantage of less work and lower costs.
Diversify and Stabilize Your Portfolio
If you’re new to investing and don’t have many investments in your portfolio, a real estate fund is a great way to quickly add a lot of diversity. Remember that when you invest in a real estate fund, you’re actually investing in several different properties and real estate-related securities. The fund itself may be highly diversified if it invests in several different types of properties across various geographic regions, REITs, and other assets.
Real estate prices are generally independent of the stock market. Just because stock markets are on the downswing doesn’t mean that real estate investments will start losing money. Adding a real estate fund investment to your portfolio can offer greater stability and help balance the risks of more volatile stocks.
Potential for Competitive ROI
Real estate investment funds present an opportunity for potentially competitive returns on investment. This is due to the fact that they pool resources to access a wide variety of real estate-related investments, which individual investors might not be able to access on their own. Typically, if you were to buy into several individual real estate investments, you’d bear the full brunt of transaction fees for each investment. In a real estate fund, that cost is shared across all shareholders. While the price of stocks may fluctuate during periods of inflation, rents could see an increase, potentially benefiting some real estate investments. It’s important to note that, as with any investment, there’s no guarantee of returns, and all investments carry risks.
A Hands-Off Approach
One of the appealing aspects of real estate investment funds for many is the reduced need for direct involvement. Rather than having to deal with the daily challenges of property ownership, such as maintenance, tenant relations, and property taxes, these are handled by the fund managers. When you invest in a mutual fund, the responsibilities of collecting rent, building maintenance, and making investment decisions are managed by professionals. This means that investors can potentially enjoy the benefits of real estate investment without some of the typical challenges faced by direct property owners. However, it’s essential to understand that a hands-off approach doesn’t equate to zero risks or responsibilities. It’s crucial to stay informed and monitor your investments regularly.
Evaluating and Choosing a Suitable Real Estate Investment Fund
Entering the realm of real estate investment can feel like a challenge, particularly when it comes to selecting a suitable investment fund. However, by focusing on certain key considerations, you can simplify the process and make a more informed choice. Here are the main aspects you should consider:
A fund’s track record can provide a useful context for future success. By studying how the fund has performed under various market conditions, you can get a sense of its potential resilience and profitability. It’s important to assess the consistency of returns and not just the highs.
Management Team’s Experience and Reputation
The skills, knowledge, and integrity of the management team are crucial factors. Look for teams with a proven track record in real estate, a deep understanding of the markets they operate in, and a history of ethical conduct.
It’s vital to understand how the fund charges its investors. Fees can significantly impact your investment’s net return, so make sure they’re competitive and transparent. Some funds may offer unique structures, such as a chance to invest as a Limited Partner and receive benefits akin to a General Partner, including share in development-related fees.
The fund’s investment approach should align with your financial goals and risk appetite. For instance, does the fund focus on residential, commercial, or mixed-use properties? What geographical areas does it target? Some funds may choose high-growth areas known for factors like population growth, rental growth, job growth, affordability, and quality of life.
A well-diversified real estate fund can help spread risk. Look at the fund’s portfolio to see if it has a healthy mix of assets. Some funds may diversify across different real estate asset types, such as multifamily, community development, mixed-use, and self-storage.
Ready to Invest in a Real Estate Fund?
Adding more diversity to your portfolio is never a bad idea, and a real estate investment fund is an efficient way to get started. The Arabella Real Estate Fund portal always has new investment opportunities for you to explore and join. Create your profile today to get started.
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