REITs' Rally Could Be Grounded

Lipper data shows the average expense ratio on a closed-end REIT fund is about 0.77%, excluding any leverage costs. (When a fund borrows to increase its holdings in a particular REIT, it must pay interest on the money it uses.) The use of leverage in closed-end funds can amplify returns, but also increase both risk and expense, Cassidy says. Open-ended funds have an average expense ratio of 1.66%, according to Lipper.

Cassidy and others caution that while the secret to real estate success is location, location and location, the key to real estate investment fund success is timing.

Other investors may have already beaten you to the punch. Analysts and financial advisers believe many of these funds are now overpriced, and some worry that new real estate enthusiasts are overlooking the volatility and pricing of the investment trusts that make up the funds' underlying investments.

"Right now the real estate market is -- I would say fairly valued is an understatement -- I would say it's fairly high," says Judith Lau, a financial planner in Wilmington, Del.

The real estate investment trusts themselves have also lost a bit of their appeal because recent tax cuts have reduced the tax advantages of investing in them, says Dan McNeela, a mutual fund analyst at Morningstar. When a portfolio of real estate holdings is set up as a REIT, the corporate structure requires it to pass 90% of its earnings on to investors, which generally prevents it being hit with the same tax rate as other corporations.

There are different types of REITs -- equity REITs that take equity positions in real estate and then pass along rental income and gains from the sale of property; mortgage REITs, which specialize in lending money to developers and get their income from the interest payments; and hybrid REITs, which mix equity and debt investments.

The mutual funds that invest in REITs, from the Vanguard REIT Index Investor (VGSIX) fund to the family of funds run by Cohen & Steers, including the Cohen & Steers Realty Shares fund (CSRSX), distinguish themselves by the types of real estate trust in which they invest. Some will focus on commercial real estate, others on residential developments, while other portfolios may load up on REITs that own nursing homes or shopping malls.

A look at different sectors should guide any considerations about investing.