REIT to Rental Real Estate...good idea?

[siralkaloid]

I've come up with a plan to save/invest my way into my first home but am unsure of the possible repercussions and would like the Mustachian blogger's opinion. I've been looking into REIT's lately, specifically the Vanguard REIT Index Fund and considered it as an effective vehicle for saving a down payment for a home. The goal is to rapidly save a large down payment and cash out the REIT, investing it in the house. Will their be tax penalties for doing this? Will this investment result in unnecessary risk by moving from broad diversification to a more narrow investment? If this is an over all bad idea, does anyone have a different recommendation for saving towards a real-estate purchase? Any assistance is greatly appreciated. Thank you in advance.

[yolfer]

I wouldn't do an REIT. They're very tax-inefficient* and also pretty risky. Even Vanguard's REIT index (VGSLX) only invests in 121 stocks, and states: "One of the fund’s primary risks is its narrow scope, since it invests solely within the real estate industry and may be more volatile than more broadly diversified stock funds."

Just because the money is going to a mortgage down payment, doesn't mean you need to invest in real estate while you save up for the down payment. If you're saving up over a period of 3 - 10 years, I'd look into Vanguard's LifeStrategy funds:

https://personal.vanguard.com/us/funds/vanguard/LifeStrategyList

You can pick one based on how long you plan on saving.

* see http://www.bogleheads.org/wiki/Principles_of_Tax-Efficient_Fund_Placement which is like a firehose of tax/investing information, but keep rereading it (and asking questions here) until you grok it.

[siralkaloid]

I really appreciate the link to Bogleheads, it looks like a very information site. My concern with the LifeStrategy Income Fund is it's lower yield over a short period of time. I would imagine its target audience are those who cannot afford risk, who are closer to retirement which is why it's so heavily weighted in bonds...In my current situation I can afford risk. I'm 22 years old and have about 6 grand in the Vanguard 500 fund for starters. I'm hoping for a short term, more risky investment to expedite my saving for my first home/rental property. Any other ideas?

[the fixer]

First of all, you should realize that investment returns over a 3-5 year time horizon are not very large. Open up Excel and check out the results of the following:
=1000*48 (principal from $1000/month for 48 months)
=FV(0.05/12, 48, -1000) ($1000/month for 48 months at 5% return, compounded monthly)
=FV(0.1/12, 48, -1000) ($1000/month for 48 months at 10% return, compounded monthly)

spoiler alert: each of the above is only ~$5k higher than the previous one. Weigh that against the risks of a volatile stock market.

As for REITs specifically as a savings vehicle for real estate, I've seen this advice: http://www.obliviousinvestor.com/using-reits-to-save-for-a-down-payment/

[leaderscorp]

This REIT is not that bad as what others are thinking. You just need to get to the right person or office so that you will get some further explanation regarding REIT.

[Kriegsspiel]

I'm investmentarded, but the yield on the Vanguard REIT is pretty much the same as on the TSM fund.  So meh.

[footenote]

Whoops - I tried to general search on REIT earlier today and found nothing. Just posted on the general investing board a similar question...

I can report that the private REIT we have been invested in for the last eight years has been one of our best investments (12% average dividend yield per year, although admittedly bumpy year to year). YMMV.