Mutual funds that invest in real estate investment trusts paid off in a big way for investors last year — as long as they stayed within the United States. The average domestic real estate mutual fund returned more than 6% last year, about 400 basis points more than the S&P 500.
The performance helped push assets in real estate mutual funds to $53 billion, from $46 billion in 2010.
The picture outside the United States wasn't as rosy.
Global real estate funds lost an average of 10% last year.
The funds were rocked by an implosion in the Asian and Hong Kong housing markets, said Steven Brown, portfolio manager of the $950 million American Century Real Estate Fund (AREEX).
The U.S. market was fueled by steady — but not spectacular — growth in demand for commercial real estate, including apartment buildings and office space, he said.
Mr. Brown said that he expects those sectors to remain strong through the first half of this year, with Canada, Switzerland and the United States outperforming real estate investments in other countries.
But principal growth has never been the primary driver of real estate investing. In a world where the average money market fund is yielding just 0.02%, or $20 for every $10,000 invested, real estate's income-generating ability has become an even bigger draw for investors.
REITs are yielding about 3.5%, down from the historical average of 6% to 7% but still richer than what is available in the high-grade-bond market. Yields have been depressed across the board by historically low interest rates, which the Federal Reserve has signaled will stay that way until at least 2013.
“Investors are stretching out to get income and looking for any investment that gives a reasonable yield in a low-income world,” said Russ Koesterich, global head of investment strategy at BlackRock Inc.'s iShares unit.
DIVERSIFICATION AND INCOME
Investing in REITs through an actively managed mutual fund not only gives investors diversification but also offers the chance to get more income than can be gotten in the general REIT market. The Pimco Real Estate Real Return Strategy Fund (PETAX), the best-performing real estate mutual fund last year, has a yield of more than 13%, for example.
Closed-end funds, which issue a fixed number of shares that trade intraday on an exchange, also offer investors access to REITs, and often with higher yields than the average real estate mutual fund.
The average closed-end real estate fund has a yield of about 7.5%, according to Morningstar Inc. Closed-end funds are able to boost the yield by using leverage, which can of course increase risk.
“The extra risk is the trade-off for the higher yields,” said Cara Esser, a closed-end-fund analyst at Morningstar.
The leverage hurt in 2008, when the average closed-end real estate fund fell 57%, compared with 39% for open-end real estate funds, but allowed the funds to come roaring back in the aftermath, gaining 53% in 2009, compared with a 31% gain for open-end real estate funds. Part of the turnaround was because closed-end funds didn't have to sell assets in order to meet redemptions, as the number of shares is fixed.
Having a fixed number of shares also means that the funds typically trade at either a discount or premium to their net asset value. Presently, shares of closed-end real estate funds are trading at about a 12% discount to NAV, up from 7% at the beginning of last year.
Investors also have the option of owning passively managed ETFs to get their real estate exposure. Real estate ETFs track an index of real estate investment trusts, such as the MSCI U.S. Real Estate Index.
Because ETFs have to disclose holdings daily, unlike mutual funds, which have to disclose holdings only quarterly, investors can see exactly which REITs they are buying, Mr. Koesterich said.
The ETFs also offer a more segmented approach to real estate investing.
Real estate ETFs also are typically the cheapest way to invest in a diversified basket of REITs. The average real estate ETF charges 0.41%, while actively managed mutual funds charge an average of 1.43%.
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