Investing in Real Estate With REIT Funds

How to Invest In Real Estate With REIT Funds

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Learn more about investing in real estate and REIT funds. Getty Images

A good way for everyday investors to gain access to the real estate sector is with mutual funds that invest in real estate investment trusts -- funds that are best known as REIT funds.

What Are Real Estate Investment Trusts (REITs)?

A real estate investment trust (REIT) is an entity that represents a collection of investors that pool their money together to purchase income producing properties, such as office buildings and hotels.

REITs usually have at least 100 shareholders and REITs are legally required to pay out at least 90% of their income to shareholders.

While REITs sound like mutual funds, they are not the same as mutual funds. Most real estate sector funds invest in REITs but they are not themselves REITs. 

The Real Estate Sector and Investing in REIT Funds

Real estate is sometimes considered to be a sub-sector of the financials sector, which includes banks, credit card companies, insurance companies and brokerage firms.

There are many mutual funds and exchange-traded funds (ETFs) that specialize in real estate and REITs but the best way for most investors to gain broad exposure to the REITs and the real estate sector is with index funds and ETFs. There are several to choose from but one of the best REIT index funds is Vanguard REIT Index (VGSNX) and one of the best ETFs is iShares Cohen & Steers REIT (ICF).

As you might imagine, REIT funds are attractive for their high dividend payouts (high yields) but they are also good diversification tools because real estate securities don't always move in unison with broader stock market index prices.

Therefore REIT funds can be used as a smart diversification tool in a portfolio of mutual funds.

A Few More Tips and Cautions on Investing in Sector Funds

Just remember not to allocate too much of your portfolio assets to REIT funds or other concentrated sector funds like them. Other sectors include utilities, technology, consumer staples, consumer discretionary, natural resources, transportation, healthcare, and defense.

A good allocation for sector funds is around 5% but not more than 10%. For example, if you choose to hold three sector funds in your portfolio, you might allocate 5% to each of them for a total of 15% allocation. The remainder of your portfolio might consist of an S&P 500 index fund, a foreign stock fund, a small-cap stock fund, and a bond fund.

Investors are also wise not to chase performance and avoid buying mutual funds after they've had extremely strong performance.

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.