How to Choose a REIT Mutual Fund

Purchasing shares in a REIT mutual fund lets you invest in income-producing commercial or residential real estate without having to buy and manage individual properties. Equity REIT funds hold the stocks of real estate investment trusts, or REITs, organizations that manage dozens of properties and collect rents each month. These trusts focus on office, shopping mall, apartment and other rental properties, and the mutual funds that hold these trusts provide diversification and stable income for the average investor.

Things You'll Need

• Internet access

Instructions

1. Understand how REIT funds work. REITs do not pay corporate income taxes, but in exchange for this privilege they must distribute 90 percent of their profits each year to investors. Similarly, a REIT fund must turn over profits from its REIT holdings to fund shareholders in the form of dividends. These dividends typically are distributed on a quarterly basis.

2. Research management styles. Actively managed REIT funds buy and sell shares of REITs throughout the year based on research and investment goals. Passively managed funds, also known as index funds, buy and hold REITs to mirror a REIT index, so very little, if any, buying and selling takes place during the year. Active management generates higher maintenance fees than passive management.

3. Compare expense ratios. An expense ratio is an expression of the administrative costs required to operate a mutual fund. The higher a fund's expense ratio, the more you will pay over time to own shares in that fund. Actively managed REIT funds carry higher expense ratios, typically higher than 1 percent, and passively managed REIT funds can have expense ratios as low as 0.26 percent.

4. Investigate redemption fees. When you read a REIT fund prospectus or fact sheet, make note of whether the fund charges a redemption fee. To discourage frequent selling of shares, some REIT funds charge a redemption fee of up to 1 percent if shares are held less than a year.

5. Determine how much of your portfolio should be in REITs. Some financial planners recommend that investors allocate 10 percent to 20 percent of total holdings in the REIT sector, according to MSN Money, which can be accomplished via a REIT fund. Keep in mind that while REITs tend to be diversified in the types of income-producing properties they hold, REIT funds operate in a tight niche -- real esate -- that should not be overrepresented in an average portfolio.

6. Decide what type of account to hold a REIT fund in. Significant dividend returns make REIT funds an attractive option for investors, but these dividends are considered income by the Internal Revenue Service. If your REIT fund is held in a tax-deferred account, these distributions can be reinvested without tax consequences. If your fund is held in a taxable account, your income from dividends must be reported at tax time.

Tips & Warnings

• Use independent research firm Morningstar for comparative research. Morningstar offers a variety of information on mutual funds on its website. To look up basic REIT fund information, type the fund's ticker symbol into the "quote" box at the Morningstar homepage and the fund page will appear.

References

• CNN Money: Picking the Sweet Spot in Real Estate
• Financial Web : What Does a REIT Fund Have to Offer?
• MSN Money: REITs: Own Real Estate Without the Hassle
• Morningstar: Benefits of REITS
• "New York Times": Just How Much Steam Do REITs Have Left?

Resources

• Morningstar: Home Page
• REIT.com: All About REITs