Common stock market investments include stocks, bonds, index funds, and mutual funds. Another common type of real estate investment that you may want to consider adding to your investment portfolio is a real estate hedge fund.
A standard hedge fund is a kind of limited partnership of numerous investors who pool their money together before making investments, which could be something like making an investment with borrowed money. The goal of a hedge fund is to obtain substantial capital gains while hedging against the inherent risk of investing. This portfolio is managed by a professional management firm on behalf of its investors.
When looking specifically at real estate hedge funds, this type of investment has been increasing in popularity over the past decade. While hedge funds can consist of liquid assets that can quickly be converted into cash if need be, hedge fund management firms are accepting more and more real estate as a kind of non-traditional investment. Of the many hedge funds that are in operation throughout the country, nearly 40 percent of them are heavily investing in real estate at the moment.
If you are interested in real estate investment, a real estate hedge fund may be an opportunity for you to diversify your portfolio. If your portfolio is currently comprised of some low-risk, low-return investments, real estate hedge funds are a great way to balance your portfolio. Before you go forward with investing in real estate hedge funds, it’s essential that you know how these hedge funds work, which is detailed in the guide below.
How Do Real Estate Hedge Funds Work?
A real estate hedge fund is a popular type of investing that involves pooling capital from numerous investors before making a single investment in some form of real estate. While hedge funds are very similar to mutual funds, the core difference is that hedge funds generally take on more risk than mutual funds. With any real estate hedge fund making investments in real estate, there are different ways in which a hedge fund manager can choose to make these investments, which depends on the investment strategy that each firm uses.
The most common method of investing via a real estate hedge fund is with a REIT. When you make an investment with a real estate investment trust, the company in charge of the trust essentially owns and operates various types of real estate that can produce income. In many cases, a REIT can be traded on numerous major exchanges. When a hedge fund invests in real estate, it can do so via the publicly-traded stock of existing real estate companies like REITs. When the hedge fund that you’ve invested in decides to invest in a REIT, you can be provided with long-term returns, dividend yields, and portfolio diversification.
Along with investing in REITs, another method of investing in real estate hedge funds is through the acquisition of properties. In most cases, the properties that are acquired by real estate hedge funds are performing poorly in comparison to the wider market, which means that their value could have recently dropped by a significant amount. The benefit of investing in under-performing properties is that these investments can be made at below market rates, which helps to reduce risk. The properties that are invested in by a hedge fund can be centralized in one location or can be purchased from all over the world.
The main difference between a REIT and an investment into an actual property is that a pure real estate hedge fund owns property. On the other hand, a real estate hedge fund that’s centered around a REIT will own stock of real estate companies. Keep in mind that different real estate hedge funds can focus on different things. For instance, some hedge funds will purchase sizable hotels that they can then develop and earn money from. Others invest in debt securities. The strategy that you want to take all depends on the kind of investment you believe will be most successful.
What is the Difference Between Hedge Funds and Mutual Funds?
Hedge funds and mutual funds are two similar forms of investing that come with distinct differences that you should keep in mind. Both of these methods for investing involve the formation of investment partnerships with many individual investors. A firm will manage portfolios that have been built from pooled capital with the primary goal of obtaining higher returns via greater diversification. When you invest into a mutual fund or hedge fund, it’s important that the investment strategy of the managing firm matches your investment strategy.
There are two key differences between hedge funds and mutual funds that you should be aware of. First of all, mutual funds are regulated by the SEC, which means that there’s a limit to how much leverage a mutual fund can take on. As opposed to liquid assets, leverage is borrowed capital that can be acquired when making an investment. Since there’s a cap on the amount of borrowed capital that can be obtained with a mutual fund, this type of investment is considered to be less risky when compared to hedge funds.
Since mutual funds are regulated by the SEC, they are available for daily trading and can be purchased by the public if you’re looking to buy shares in a mutual fund. Because real estate hedge funds aren’t regulated in the same way that mutual funds are, they are considered to be private investments that can only be purchased by accredited investors. The main benefit of investing in a real estate hedge fund is that you can generally obtain higher returns than are possible with a mutual fund. As long as you qualify as an accredited investor, a hedge fund is a way to take on more risk with your portfolio, and in turn, potentially higher yields.
How Do I Invest in a Hedge Fund?
While it’s possible for you to invest in a hedge fund, there are some basic restrictions and guidelines that you should be aware of before attempting to do so. The types of investors who can join the investor pool in a hedge fund must have the ability to make high risk investments. Regulation D places a limit on the number of investors who can join a hedge fund, which is why the investment amount for each is generally on the higher end. The managers and general partners of a hedge fund are in charge of setting minimum investment requirements.
While the minimum investment requirements differ with each hedge fund, they can be anywhere from $100,000 to $1 million. Since real estate hedge funds aren’t regulated directly by the SEC, most investors will need to be accredited. A small number of hedge funds are listed on exchanges, which means that shares of the hedge fund can be purchased via a broker or individually.
How can Hedge Funds Make Big Profits in Real Estate
Before you join a real estate hedge fund, it’s important that you understand the advantages and disadvantages that come with hedge funds.
Advantages of Hedge Funds
When you want to make money in real estate, a hedge fund provides you with the opportunity to bring in high returns for some potentially large profits. Since these investments can be made in a variety of ways with real estate hedge funds, it’s possible to obtain positive returns in both falling and rising markets. You can also customize your investment strategy in any way you see fit. These hedge funds are managed by some of the top investment managers in the world, which somewhat reduces the risk that comes with making such an investment.
Disadvantages of Hedge Funds
However, there are some negative aspects of hedge funds that you should be aware of. For instance, the losses can be substantial if the hedge fund fails and your investments don’t pan out. There’s also much more leverage in a hedge fund when compared to liquid assets, which heightens the risk of a hedge fund. Because hedge funds aren’t liquid, your money can be locked up for long periods of time.
In most cases, hedge funds will last around five years. However, it’s possible for a hedge fund to fail in less than a year. You should start to see returns for your investment after the first year depending on the terms of the hedge fund. The key to a successful real estate hedge fund is to join a reputable hedge fund management company.
Investing in Real Estate Hedge Funds
When you’re considering your many investment options, real estate hedge funds can be highly beneficial for your portfolio in a variety of ways. While hedge funds may be riskier than other investment methods, they also allow for the possibility of higher returns. If your portfolio is balanced, hedge funds are actually able to reduce the risk of your portfolio while increasing returns at the same time. There are also several different ways to invest with real estate hedge funds. Your investments can go into actual properties or can be invested into a REIT, which allows you to select the option that best matches your portfolio strategy.
*Disclaimer: The statements and opinions expressed in this article are solely those of AB Capital. AB Capital makes no representations, warranties or guaranties as to the accuracy or completeness of any information contained in this article. AB Capital is licensed by the Financial Division of the California Department of Business Oversight as a California finance lender and broker (DBO Lic. No. 60DBO-69427). AB Capital makes money from providing bridge loans. Nothing stated in this article should be interpreted, construed or used as legal, financial, investment or tax planning advice, or a substitute for thorough due diligence and the exercise of sound independent judgment. If you are considering obtaining a bridge loan, it is recommended that you consult with persons that you trust including but not limited to real estate brokers, attorneys, accountants or financial advisors.