If you have looked at real estate as a possible way to diversify your portfolio lately, you probably have a host of reasons to stay away. These are likely to include: uncertainty about the market, illiquidity, the high dollar amount needed for a down payment, cash flow requirements and the hassles of dealing with tenants.
All of these may be overcome easily by investing in real estate indirectly.
The exchange-traded fund or ETF is an ingenious kind of mutual fund. Unlike the old type, in which a team of managers decided where to invest, the ETF has a predefined “basket of securities.” The ETF is designed to focus on one market, such as real estate. (Other ETFs focus on market sectors, currencies, commodities, or countries.)
Another compelling feature of the real estate ETF is that you can buy and sell shares instantly through the stock exchange. ETF shares act just like stocks, enabling traders to move in and out of positions through online order placement. Old-style mutual funds always settled at the day’s closing price, and only through the fund management.
Here’s a sample of real estate ETFs:
iShares Dow Jones US Real Estate (IYR)
iShares Cohen & Steers Realty Majors (ICF)
PowerShares Active U.S. Real Estate (PSR)
NOTE: None of these are recommended specifically; this list is a starting point for further research.
You can also buy shares in ETFs focusing on real estate investment trust (REIT) shares. The REIT is always a diversified real estate investment, so this is like buying a two-tiered diversified fund. Among these are:
Vanguard REIT Index ETF (VNQ)
SPDR Dow Jones Wilshire REIT (RWR)
iShares FTSE NAREIT Mortgage Plus Cp. Index (REM)
iShares FTSE NAREIT Residential Plus Cp. Index (REZ)
First Trust S&P REIT Index (FRI)
iShares FTSE NAREIT Real Estate 50 (FTY)
Wilshire US REIT ETF (WREI)
iShares FTSE EPRA/NAREIT North America (IFNA)
iShares FTSE NAREIT Retail Cp. Index (RTL)
PowerShares KBW Premium Yield Equity REIT (KBWY)
Some of the REIT-specific ETFs focus on equity real estate, while others buy real estate mortgages. Before picking any REIT, you should be sure that you understand the mix of securities in the ETF basket.
When you buy real estate directly, limited capital invariably also limits the number of properties you can buy as well as location. Cash flow is always an issue as well, so you have to know how strong or weak rental demand is when you buy. The ETF solves these problems by holding a variety of different real estate, through corporations or REITs. However, this does not replace the need for research, a point too easily overlooked. Just as you want to research a traditional mutual fund to make sure it matches your risk tolerance, the ETF market has to be studied carefully before money is put into the purchase of shares.
Michael C. Thomsett is author of over 60 books, including Getting Started in Real Estate Investing (John Wiley and Sons), and The Landlord’s Financial Toolkit (Amacom Books Press). Thomsett’s website is www.MichaelThomsett.com. He lives in Nashville, Tennessee and writes fulltime.