The talk of the homebuilding boom and the great dividends of REITs lure investors in search of "safe" returns. As the chart further below shows, REITs -- as measured by the Morgan Stanley REIT Index -- significantly have outperformed the market over the last year. In fact, over the last three years, REITs have gained more than 45%, while the S&P 500 has lost more than 30%.

However, that doesn't mean real estate equities are for all portfolios. Even as REITs seem to provide stability, especially in today's tumultuous market, it's important that investors understand the risks associated with investing in the sector.

Rose-Colored Windows

With the average REIT yielding more than 7%, investors are flocking to the income-producing stocks as a security blanket, a way to protect principal in a challenging market. But with a large part of the stock market's difficulty resulting from an anemic economy, investors may be looking past the potential impact of economic troubles on REITs.

Take office landlords. As the economy slows, demand for office space drops. That means lower occupancy and lower rents. In the San Francisco area market, for example, rents were cut in half as tenants defaulted on leases at the same time new supply was coming to market. With the exception of the Washington, D.C., and New York markets, office landlords have struggled and office REITs barely have provided break-even total returns during the last year.

Other REIT groups have done quite well in the slowing economy. With consumer spending seemingly undaunted by the economic slowdown, retail REITs have posted a nearly 28% total return over the last year, led by regional mall REITs.

However, retail property tends to be a lagging indicator and signs of softness in the sector are emerging as major mall tenants like Gap (GPS - commentary - Cramer's Take) continue to pare back new store openings. Add to that bankruptcies from retailers like Kmart, and the amount of space on the market will serve to pressure rent growth for retailers.

The dividends and lack of alternatives continue to push investors into REITs. And demand for shares of REITs has been a big contributor to the outperformance of real estate stocks in the past three years. Still, it's important to recognize that REITs are less liquid than many other sectors and a sharp positive turn in the broader market could put pressure on REIT prices in the same way the sector has benefited from recent market weakness.

Playing It Safe

As I have described in a series of columns in the last three years, one formula that provides both upside potential with downside protection is adopting a strategy of growth at a reasonable price when investing in REITs. When REITs are undervalued, several REITs pass the test; when REITs are near fair value, few make the list, like last quarter.

If you are considering investing in real estate stocks, look for these attributes as you select REITs:

Companies that made my most recent screen include Developers Diversified (DDR - commentary - Cramer's Take), United Dominion (UDR - commentary - Cramer's Take), ProLogis (PLD - commentary - Cramer's Take) and Health Care REIT (HCN - commentary - Cramer's Take).

The checklist should help protect you against disasters and give you a chance to select potential winners. The real estate market is very close to fair value and faces the dual challenge of weaker fundamentals and potential competition from other market sectors.

Double Take: Sept. 19
What's your take on the REIT sector?
	The gains are over -- it's all downhill from here.
	It's a mixed bag, depending on which segment (retail, apartments, etc.) you're looking at.
	It's still set to outpace the broader market.