REITs' Rally Could Be Grounded

After four years of outsized returns and star status in a down market, experts don't think real estate funds will be raising the roof much longer.

Though they are outpacing stocks, bonds and just about everything but the long-short daily double at the dog track, prospective investors should heed the experts, who think real estate investment trusts, or REITs, can't sustain their recent rates of return.

High rates of home buying and a general building boom helped push the indices that track REITs -- the securitized versions of real estate portfolios -- to record levels, especially in the past 15 months. But with interest rates about as low as they can go, the entire real estate sector is due to cool, and that calls for caution, even in the face of attractive numbers from REIT mutual funds.

With year-to-date total returns of the approximately 65 open-end REIT mutual funds at 7.01%, according to fund tracker Lipper, they look like a great way to avoid some of the risk of an equity market correction and still register bang-up returns. With a whopping 2003 average total return of 48.73% and a five-year average total return of 16.23%, the REIT-powered bounty of real estate funds looks all the more seductive, but look at them with a wary eye. By comparison, the S&P 500's total return for the year to date is 3.25% and its 12-month return is 38.52%, but the index's five-year return is still a loss of 0.12%.

Real estate should be a constant component of a diversified investment portfolio, but the recent outsized returns are prompting investment professionals to downsize their clients' allocations. Although REIT funds aren't tied to the performance of the equity or fixed income markets, they can still be volatile, warns Don Cassidy, an analyst with Lipper.

"You can still make a case for REIT funds because they tend not to correlate with other asset classes," he says. "But I have some concern that people are following the easy path to yield and ignoring the risk."