3 Secrets to Investing in Real Estate: Real estate is a great way to diversify your portfolio.
March 1, 2014
First, let me tell you a small secret of my own. I expected to write this article in no time flat, highlighting an international real estate investment trust that I’ve owned for many years. I was wrong.Although my fund is included, there are several other excellent REIT options you need to understand. I'll expose you to the best and cheapest U.S. and international real estate investing options, and I’m not talking about running over to Europe or Asia with checkbook in hand.Real estate investing street cred. I’m a professional investment portfolio manager for a privately held real estate holding company. In addition to a real estate portfolio, we hold financial assets. I’ve been around real estate forever, as my parents owned a real estate company since the middle of the last century.Personally, I’ve owned many investment properties. Managing individual real estate is fraught with aggravation. It’s such a pain in the neck, that apart from our own residence, and in spite of the potential financial gains, I do not own any individual real estate outright.Real estate is an excellent way to diversify your portfolio. One of the major tenets of investing is diversification. With diversification, the investor can increase returns while smoothing out and reducing risk. The less correlated an asset class is with another, the greater benefit there is from adding it to your investment portfolio.Real estate, U.S. and international, offers a diversification benefit to investors of all ages and stages in life.There is a way to invest in real estate and benefit from the cash flow which comes from renting out that real estate without the aggravation of managing tenants and fixing broken pipes in the middle of the night.As with any investment, stocks, bonds and buying and selling apartment buildings, there is a risk that the value of your investment will go up and down. That said, over time, real estate values have appreciated. That means, as a long-term real estate investor, you are likely to increase your returns by putting part of your cash in real estate investments.3 ways to invest in real estate quickly and easily. If you’ve ever invested before, you understand that mutual funds and exchange-traded funds offer a cost effective method to participate in the growth of both U.S. and international businesses. Plop down your cash in a diversified stock-index mutual fund such as Schwab Total Stock Market Index Fund and voila, your money is poised to grow along with the companies included in the fund. The same strategy holds for ETFs, which are simply mutual funds that trade during the day on financial stock exchanges.If you’d like a bit more exposure to real estate in your investment portfolio, then here are three real estate funds to consider:For investors new to real estate or real estate investment trust investing, here is the Cliff Notes definition from Investopedia:“A security that sells like a stock on the major exchanges and invests in real estate directly, either through properties or mortgages. REITs receive special tax considerations and typically offer investors high yields, as well as a highly liquid method of investing in real estate.”1. For exposure to the entire U.S. real estate market, Vanguard REIT Index ETF is a great alternative. For full disclosure, I have owned this ETF in the past and may currently hold shares as well.What’s so great about Vanguard REIT Index ETF? In one fund, the investor accesses a range of property types including commercial malls, hotels, and apartments. The fund holds shares in more than 120 different real estate companies. If you’re looking for income, REITs are required by law to pay out all earnings, thus it sports a juicy 4.14 percent yield. This fund also has the lowest expense ratio in its category.What is the down side? The REIT is a bit highly valued according to it’s lofty 38 P/E ratio. When interest rates rise, as is likely in the future, REITs will suffer as they will need to direct more cash flow to debt repayment than dividends.2. The Vanguard Global ex-U.S. Real Estate ETF rounds out a real estate portfolio wit low cost international real estate from 35 countries. A further advantage to this international REIT is that it is the only fund to include emerging-market real estate. Since U.S. real estate companies make up less than 50 percent of the total real estate securities, it makes sense to allocate funds to international real estate as well.What else does Vanguard Global ex-U.S. Real Estate ETF have going for it? It is less correlated with U.S. real estate, thus it offers additional diversification benefits. The fund has the lowest expense ratio among its peers at 0.32 percent, a whopping 76 percent lower than its peers. Add a 3.44 percent yield and there are some compelling reasons to own international real estate.No investment is without a downside. International real estate is more volatile than U.S. REITs. As China struggles, international real estate could feel a pinch.3. For the easiest approach, SPDR Dow Jones Global Real Estate ETF covers the entire real estate world. This is a one-stop shop for both U.S. and international REIT exposure. The fund is evenly split between U.S. and international holdings.The ETF offers a 3.77 percent yield as of February 2014. This is a great dividend, but remember that if the price declines on this or any dividend paying asset, the total return will also fall.With an annual expense ratio of 0.50 percent, investors could access similar real estate exposure at a lower cost by purchasing using a combination of lower cost U.S. and international REITS.So, are REITs a holding for your investment portfolio? The answer is a resounding maybe. Understand your own risk tolerance and realize that in the current low interest rate environment, these investments may decline in value if interest rates spike upward. On the flip side, a high-yield investment may be desirable for your personal portfolio.Over the long term, owning real estate through REITs is a good way to diversify your portfolio without those pesky middle of the night phone calls from unhappy tenants.