For many of us, owning a house is a dream. However, with real estate prices going through the roof, owning a house remains a dream for many. This should discourage you from investing in the real estate market and make the most of this growth. There are many alternatives to investing in a house or a piece of land or house. One of the most popular alternatives is real estate mutual funds. In this article, we cover real estate mutual funds, its features, advantages and risks in detail.
What are real estate mutual funds?
Real estate mutual funds are sectoral funds that primarily invest in securities of real estate companies or in Real Estate Investment Trusts (REITs). The fund manager pools money from investors and invests in these companies. So technically, the fund manager is providing the real estate companies with capital to build and develop properties. When the share price of these companies rises, or when the real estate market goes up, the mutual fund will make a profit.
Following are the features of real estate mutual funds.
- Minimum investment: With the ever-rising prices of real estate, investing in this sector has become out of reach for the common man. However, in the case of real estate mutual funds, you can still participate in this sector with a minimum investment of Rs. 1,000.
- Investment horizon: Real estate is a long-term sector, as it takes time to build and sell property. Hence the ideal investment horizon for these funds is over five years.
- Alternative to buying a property: Real estate funds are an excellent alternative to buying a physical property. It eliminates the risk of litigation and the hassle of maintaining a property. Moreover, it also reduces the time and effort in buying a property.
- Returns: Real estate fund’s return depends on the real estate sector. However, in the long term, these funds can offer decent returns.
- Risk: Real estate funds are prone to sector risk. If the sector collapses, so will the companies in the industry, which will affect the fund.
- Liquidity: Real estate mutual funds are very liquid when compared to physical property. Investors can cash out their investments and get the investment proceeds in their bank account within a day.
- Expense ratio: Real estate mutual funds have an expense ratio similar to other mutual funds. It is usually a percentage of the investment amount.
- Profit sharing with long-term growth: Real estate mutual funds invest in REITs and shares of real estate companies. The fund can earn profits from REITs and enjoy long-term growth benefits from shares of real estate companies.
- Minimal investor’s effort: Investing in real estate funds doesn’t require you to go through a ton of paperwork, and it also reduces the hassle of finding a good property to invest in. When it comes to real estate mutual funds, the investor’s efforts are very minimal, and they get to enjoy the full benefits.
- Diversification: Fund managers of real estate mutual funds invest across different properties, including residential, commercial, rental, and hospitality projects. Hence as an investor, you can enjoy the benefits of a diversified portfolio of properties.
- No direct role of investors: As an investor in a real estate mutual fund, you will have no control over your money as the fund manager decides the portfolio of the company. Moreover, you do not own the shares of the company directly, so you won’t have any voting rights.
How do real estate mutual funds work?
Real estate mutual funds are similar to other equity mutual funds. The manager pools money from different investors with similar objectives and invests them in REITs and shares of real estate companies. The profits arising from the REITs are distributed to all mutual fund unit holders, whereas the capital appreciation in the shares of the real estate companies will increase your portfolio returns.
Who should invest in real estate mutual funds?
Real estate mutual funds best suit small investors who lack the capital to invest in real estate properties. Since the investment in real estate mutual funds is low, it is accessible to everyone. These funds also suit investors who want to gain from the real estate market boom. If you are looking to accumulate wealth from real estate, these are your go-to funds.
Real estate funds ideally reap good returns in the long term. So, if you have a horizon of 5 years, then you can consider investing in these funds. They also help in diversifying your investment portfolio. If you want to beat inflation and protect your portfolio from downside risk, then real estate funds can be considered for investment. Finally, if you want to escape from the hassle of paperwork and eliminate the risk of litigation, then real estate mutual funds are the best fit for you.
Advantages of real estate mutual funds
The following are the advantages of real estate mutual funds:
- Low minimum investment: Real estate mutual funds have a very low minimum investment requirement, unlike actual physical property. This gives an opportunity to small investors to participate in the real estate sector.
- Flexibility to invest: Investors can invest in real estate mutual funds through SIP (Systematic Investment Plan). However, they can’t do the same with physical property without taking a loan and paying the installment through EMI.
- An excellent alternative to buying physical property: By investing in real estate mutual funds, you can participate in the real estate market and make good money without actually buying a physical property.
- Access to diversified properties: Investors having limited capital can invest in these funds and get access to a diversified set of properties such as commercial, residential, rental, and hospitality.
- Liquidity: Unlike land, house or building, real estate mutual funds are very liquid, and you can get your money in your account in a day.
- Protection against inflation: During inflation, the rent and prices of land increase, which in turn increases the value of the real estate mutual funds you’ve invested. Hence you will accumulate more wealth shielding your investments from inflation.
- Stability: In a portfolio which has equity, debt, and cash, real estate acts as an additional asset class which will bring stability to the portfolio returns and hedge the downside risk.
Limitations of real estate mutual funds
- Market risk: Real estate funds are highly dependent on the real estate market, which is, in turn, dependent on the demand for properties. In a sluggish market, the real estate fund returns are affected.
- Interest rate risk: When the interest rates are rising, the credit gets costly. This means buyers are discouraged from buying, and the seller’s financial cost would be high. This affects the real estate market, which will lead to the underperformance of the fund.
- Lack of control: You won’t have direct control over your funds or investments. The fund manager makes all investing decisions, and you don’t have the freedom to tell them where to invest. Moreover, since you don’t own the shares of a real estate company directly, you are not entitled to voting rights as well.
Taxation of real estate mutual funds
The income and capital gains you generate from real estate mutual funds are taxable as per the Income Tax Act of 1961. Following are the tax rules for real estate mutual funds.
- Short-term capital gains, that is, gains made by selling within three years (36 months) of investment, are taxable at 15%.
- Long-term capital gains, or gains made through selling after 36 months of investing, are taxable at 10%.
- Any interest income generated through REITs is taxable at the investor’s income tax slab rate.
- Dividend income is taxable in the hands of investors if the real estate company has obtained a special tax concession.
- If there is any income generated during the amortization of the special purpose vehicle (SPV), then REIT investors are not liable to pay any income tax.
REIT vs Real estate mutual funds
REITs and real estate mutual funds help participate in the real estate market. However, the similarity ends there. REITs and real estate mutual funds are two completely different investment vehicles. Below are some of the major differences between them.
Real estate mutual funds are similar to mutual funds, where it invests in shares of real estate companies. In contrast, REITs invest in mortgages, constructed properties, or under-construction properties.
Through REITs, you can directly participate in the real estate market and earn returns; however, in the case of real estate mutual funds, you participate indirectly through the shares of real estate companies.
Real estate mutual funds earn returns when the shares of underlying companies go up, whereas REITs earn income when the underlying properties earn rent, which is distributed to the investors in the form of dividends. So, if you want to earn passive income or short-term profit, REITs are a better choice. However, if you want to accumulate long-term wealth through capital appreciation, then real estate mutual funds should be your go-to choice.
You can invest in real estate mutual funds through a demat account or directly through the fund house’s website. However, you can only invest in REITs through a demat account as REITs trade on the stock exchange just like shares.
There are no subcategories of real estate mutual funds. However, in the case of REITs, there are three kinds, namely equity, mortgage, and hybrid. Equity REITs own and manage properties and earn rent through them. Mortgage REITs deal with mortgaged properties and earn through interest on mortgages. Lastly, hybrid REITs deal with both owned and mortgaged properties and earn through rent and interest on mortgages.
Frequently asked questions
Are real estate mutual funds a good investment?
Real estate mutual funds allow you to invest in shares of real estate companies, which provide diversification to your portfolio. Moreover, real estate mutual funds help fight against inflation as real estate prices go up during inflation, which positively impacts the shares of real estate companies.
What is a real estate mutual fund?
A real estate mutual fund pools money from investors and invests in shares of real estate companies and REITs. Investors can earn from the capital appreciation of shares and dividend income of REITs. You can invest in real estate mutual funds through a demat account, directly through the company’s website, or any third-party platform such as Jupiter Money.
Who should invest in real estate funds?
Investors who want to benefit from the real estate market boom can invest in real estate mutual funds. These funds also suit investors who want to diversify their investment portfolio. Moreover, investors who want to accumulate wealth in the long term and fight inflation can also consider investing in real estate mutual funds.
Since the minimum investment in real estate mutual funds is low, small investors who can’t afford to buy real estate properties can invest in these funds.
How to invest in real estate in SIP?
You can invest in real estate mutual funds through SIP if you want to participate in the real estate market. You can directly invest from the company’s website or go through a third party’s website to start a SIP in real estate mutual funds.
How can I buy REIT in India?
REITs are listed on the stock exchange, and you can invest in them directly through your demat account. Alternatively, you can participate in a REIT IPO when it is first issued. You can also invest in REIT through real estate mutual funds. However, these funds also invest in shares of real estate companies and not just REITs.
Why should I invest in a real estate fund?
A real estate fund helps you participate in the real estate market; Given the current real estate boom, you can make good profits from these funds if you choose to invest in them. Moreover, real estate funds help diversify your investment portfolio and also accumulate long-term wealth. They also help fight inflation and provide stability to your investment portfolio.
