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What are the Advantages and Drawbacks of Real Estate Interval Funds?

What are the Advantages and Drawbacks of Real Estate Interval Funds?

Real estate investors have more options today than ever, but a growing number of them are choosing interval funds to meet their alternative investing needs.

The recent popularity of interval funds should not come as a surprise; these mutual funds offer retail investors access to institutional-grade real estate investments, such as commercial real estate credit, private real estate equity and private real estate debt, while typically requiring very low investment minimums. Most importantly, interval funds tend to offer excess returns when compared to their open-ended mutual fund cousins.

At this point, the savvy investor may wonder, “What’s the catch?” The answer is that interval funds do not offer daily liquidity. Typically, interval fund redemptions are only possible once per quarter. But once real estate investors understand the upside to limited liquidity, they tend to find interval funds very attractive.

What is the advantage of quarterly liquidity? It sounds undesirable at face value, but interval funds’ limited liquidity provides real estate investors with four distinct advantages:

Access to institutional grade investments

Because interval fund managers don’t have to provide daily liquidity, they are able to invest in less-liquid, higher-return assets. Through an interval fund, retail investors can access investments in private equity and commercial real estate credit with low minimum investment. You won’t find these types of investments in open-ended funds or publically traded REITs because of their daily liquidity requirements.

Excess returns

Liquidity has a cost. Economics 101 teaches us that longer-term loans typically demand higher rates. The same principle applies to investing. Daily liquidity requires fund managers to focus on liquid assets, which all else being equal, tend to have lower returns. Interval fund managers don’t have to worry about liquidity for daily redemptions, so they can invest in higher-return assets while controlling for risk.

Low correlation to equities

Many interval funds, especially those focused on alternative investments like real estate, are not strongly correlated to equity markets. This means that interval funds may not experience volatility during equity market fluctuations. Due to the ability to invest in illiquid assets, many underlying fund assets are not traded on markets and therefore are not priced regularly. Think buying a property—the value of that property isn’t assessed daily, therefore short-term volatility in the equity markets is unlikely to affect the value of the property. The same applies to interval funds.

Impulsive behavior prevention

Behavioral economics tells us that trusting your gut doesn’t typically translate into investment success. Studies also show that retail investors continually fail to time markets correctly. Another advantage of interval funds is that their quarterly redemptions help to eliminate hasty decisions driven by fear and investors’ desire to time the markets.

So the liquidity “catch,” when it comes to interval funds, ends up being one of the greatest strengths of the funds’ structure. By limiting liquidity, interval funds offer real estate investors access to institutional grade investments with minimum investments that are low enough to be affordable for almost any retail investor.

John Snowden serves as the portfolio manager of the Resource Real Estate Diversified Income Fund (RREDX). John is based in New York and oversees the real estate security portfolios at Resource Real Estate.

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