REIT Shares Ripe for Slowdown

Taylor is advising his clients to wait it out on REITs until it's clear when the Federal Reserve will end its campaign of raising interest rates. "We're telling people it's going to be a choppy finish to the year," he says.

Last year, a record $6.9 billion flowed into real estate mutual funds and ETFs, according to mutual fund data provider AMG Data Services. That number doesn't look like it will be topped this year. As of Oct. 26, $2.73 billion has flowed into the sector. But during the last two months, real estate funds saw a total net outflow of $697 million, while money market funds are seeing their best inflows of the year.

As a result of the investor dollars that were sunk into REITs over the past few years, the group is now trading at about 14 times its projected FFO for 2005, which looks pricey based on historical multiples. In 2000, the first year of the great bull run for REITs, the multiple was 8. During the past five years, REITs have seen "multiple expansion without having the accompanying earnings growth that would, by historical measure, justify that," says Keven Lindemann, director of real estate with SNL Financial.

For REITs to trade at such lofty multiples yet only grow earnings by single-digit percentages each year "probably isn't tenable in the long run," Lindemann says.

This year, REITs as a group are expected to post their best earnings growth since 2000. However, on Tuesday a number of companies reported disappointing quarterly results that rattled the sector.

Shares of Equity Office Properties (EOP Quote), the nation's largest office owner, fell 5.8% Tuesday after the company's third-quarter FFO missed analysts' estimate. The company also opted to not give future earnings guidance, citing the uncertain effects of rising utility expenses, construction costs and interest rates.