There are many ways an investor can own real estate. Options include direct individual investment, real estate partnerships, real estate investment trusts (REITs), or real estate investment funds. The latter can be highly attractive, especially for those just beginning their real estate investing journey.

Here's a closer look at how to use funds to invest in real estate.

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What is a real estate investment fund?

An investment fund is an entity formed to pool investor money and collectively purchase securities such as stocks, bonds, or real estate. Thus, a real estate investment fund is a combined source of capital used to make real estate investments.

Real estate investment funds share some similarities with REITs in that they're both pooled sources of capital used to invest in real estate. However, there are some key differences between them, including the fact that REITs are corporations that must distribute 90% of their taxable income to shareholders to maintain their tax-advantaged status with the IRS. Real estate funds don't have to comply with those rules; thus, many earn returns for their investors via capital appreciation instead of dividend payments.

What are the types of real estate investment funds?

There are three main types of real estate funds available to investors:

  1. Real estate mutual funds: Mutual funds (real estate-focused or otherwise) are professionally-managed investment vehicles. These entities invest money pooled from investors into a diversified portfolio of real estate opportunities, including REITs, real-estate-related companies, and direct ownership of real estate. Most real estate mutual funds are open to all investors as long as they meet the minimum investment requirement. Investors can purchase most mutual funds through a financial advisor, though some are available via online brokerages.
  2. Real estate exchange-traded funds (ETFs): ETFs (real estate-focused or otherwise) are passively-managed investment vehicles. These funds track an underlying index enabling investors to earn market-matching returns (minus expenses). Real estate ETFs are open to the public and trade on major stock market exchanges.
  3. Real estate private equity funds: Private equity funds are actively managed and target institutional investors and high-net-worth clients. Because of that, most private real estate funds are only available to institutional and accredited investors, not the general investing public.

What are the benefits of investing in a real estate fund?

There are many advantages to using funds to invest in real estate. A few notable ones:

  1. Diversification: Most real estate investment funds offer investors broad exposure to the real estate sector. They typically own many property types or invest in several different REITs. That diversification helps reduce risk, though it can also lower an investor's return potential.
  2. Lower initial investment threshold: Most real estate funds have relatively low initial investment thresholds (usually less than $10,000 for a mutual fund and not much more than $100 for most real estate ETFs). That provides investors with a much lower entry point than if they bought individual properties.
  3. Passive investing: While real estate enables investors to generate passive income as tenants pay rent, being a landlord requires active management. On the other hand, real estate funds are much more hands-off investments since others handle the active management of the properties.

What are the best real estate investment funds?

Real estate investors have many excellent fund options available to them these days. Some of the top choices include:

  1. The Vanguard Real Estate Index Fund (VGSLX -0.29%). This real estate mutual fund has a minimum investment of $3,000 and charges a low expense ratio of 0.12%. The fund invests in a broad array of REITs, offering investors exposure to the entire real estate market.
  2. Vanguard also offers an ETF version, Vanguard Real Estate ETF (VNQ 0.56%), which gives investors the same broad REIT exposure and low expense ratio. Further, because it's an ETF that trades on a major stock market exchange, most investors can purchase as few as one share (which only cost about $80 apiece as of the middle of 2020) to start investing in real estate.
  3. The Real Estate Select Sector SPDR Fund (NYSE:XLRE). This EFT tracks the performance of the real estate sector in the S&P 500 Index, providing investors with exposure to real estate management and development companies as well as equity REITs. It also has a low expense ratio (0.13%) and share price (around $35 apiece in mid-2020).

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Real estate funds can be great options for investors

Real estate funds provide investors with broad exposure to real estate for a low investment level. These funds also enable investors to passively participate in real estate investments, freeing up their time for other things. Because of that, real estate funds can be an ideal option for those just starting their real estate investing journey.

Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard Specialized Funds - Vanguard Real Estate ETF. The Motley Fool has a disclosure policy.