October 25, 2021

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Why You Should Be Investing in Active Real Estate Funds

Investing in real estate isn’t a straight line. There are several different paths you can take to include property investments in your portfolio.

Real estate investment funds operate like other mutual funds but focus primarily on property investments. Some funds rely on a passive investing strategy, while others adopt an active management approach.

“Active real estate funds give investors more options,” says Jeff Checko, a real estate broker with The Ashton Real Estate Group of RE/MAX Advantage in Nashville, Tennessee. He says real estate funds afford investors more opportunity in deciding where to allocate investment dollars, versus basing decision-making solely on an average rate of return.

Similar to any other actively managed mutual fund, active real estate funds rely on the fund manager to make investment decisions. These funds can be highly specialized, targeting a narrow slice of the real estate market, or invest in real estate on a broader scale.

[See: 9 REITs Ideal for Beginning Real Estate Investors.]

If you’re not yet exploring the possibilities of active real estate funds in your portfolio, here are three reasons to consider it:

— Returns may outstrip REITs.

— Active real estate funds can help dilute portfolio risk.

— Capitalize on trends, with lower investment costs.

Returns May Outstrip REITs

Real estate investment trusts, known as REITs, are a popular vehicle for passive real estate investing. When you invest in a REIT, you’re investing in a company that owns real estate investments.

That means you’re not burdened with any of the responsibilities of owning real estate directly. You have the advantage of earning income from REITs, as they’re required to pay out 90% of dividends to investors.

REIT management and research are left to the experts, meaning you don’t have to do any heavy lifting when it comes to choosing properties. Investing in REITs also allows you to enjoy various tax benefits associated with property ownership.

Active real estate funds don’t operate along these same lines. But that can be an advantage when it comes to putting growth in the spotlight.

While REITs pay out the majority of dividends to investors, active funds offer more freedom to reinvest earnings, says Than Merrill, an expert real estate investor and CEO of real estate education company FortuneBuilders.

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“Active real estate funds are able to simultaneously enjoy the spoils of the real estate industry while using profits to scale their operations,” Merrill says.

That could translate to better returns for investors over time. But, Merrill cautions, investors should consider how that freedom and flexibility could work against an active real estate fund’s performance.

“For better or for worse, the freedom to distribute funds can introduce a number of variables to the equation,” he says. “Consequently, more can go wrong with an active real estate fund in the hands of a poor manager.”

When researching active real estate funds, it’s important to look closely at the fund manager’s track record and style. While past returns are no guarantee of future performance, that can give you an idea of the fund manager’s strengths and weaknesses.

Active Real Estate Funds Can Help Dilute Portfolio Risk

A well-balanced portfolio can offer insulation against stock market volatility, especially with an active real estate investment fund or two in the mix.

“By investing in active real estate funds, investors can spread risk in terms of ownership via a number of different assets, geographies and business plans,” says Scott Crowe, chief investment strategist at CenterSquare Investment Management.

The key is recognizing which segments of the real estate market may be the most promising when investing in active funds.

Crowe says some of the biggest opportunities may lie with active real estate funds that are focused on building new industrial and logistics warehouses. This is driven in part by increasing consumer demand for e-commerce.

Other potential hot spots for investors who are interested in active real estate include funds focused on solving affordable housing shortages and repurposing outdated office space.

When considering active funds for diversification, it’s important to look not only at the quality of the underlying assets, but also how many there are to properly manage risk.

“Smaller active real estate funds are often riskier for investors compared to a REIT because their asset base is typically more modest,” says Christopher Rogers, a senior partner at Capital Fund Law Group. “With fewer properties and investors than their REIT counterparts, a real estate fund that has an unsuccessful investment will expose the investor to a more significant negative impact in terms of profitability.”

That said, smaller funds can pay off if the fund manager knows what they’re doing. Rogers says that if there are fewer investors involved, that increases the chances of turning a higher profit since they own a more substantial percentage of the fund.

[See: 9 Must-Have REITs for Sustainable Investing.]

Capitalize on Trends, With Lower Investment Costs

Trends come and go, and an actively managed real estate fund might allow you to capitalize on them more quickly than REITs or real estate crowdfunding.

“Active real estate funds are more agile, as you’re able to jump on opportunities with less red tape and less bureaucracy,” says Ryan Wright, founder and CEO of DHM Industries, a real estate investing and lending company.

Wright says these funds typically have more liberty to look into investment opportunities and act on them, compared with other forms of investing where there may be more regulations and government oversight.

At the same time, you can benefit from lower management costs versus something like a publicly traded REIT, which trades on a stock exchange, Wright says.

What you need to watch out for is a fund manager who acts in the heat of the moment. Being too quick to jump on an opportunity can backfire if their guess about which way a trend is moving turns out to be wrong.

Investing in active real estate funds all comes down to how well you do your homework on the fund and its manager(s).

“If you’re trying to choose between different active real estate funds, research why they are raising funds,” Checko says. For example, if a fund is focused on multifamily housing in secondary markets, consider what trends in those markets might be pushing up demand for apartments.

Also, get a sense of what kinds of properties you’re investing in, how those investments are valued, how strong demand is for the underlying investment type in the market and what the fund’s overall exit strategy is before committing.

“Bottom line: You have to understand how the investment works,” Wright says. “If it doesn’t make sense to you, don’t do it.”

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