Real estate investment trusts and other real estate stocks are this year's Cinderella story, but jaundiced investors are probably wondering when the clock will strike midnight.

The average mutual fund investing in real estate is up 22.7% year to date through Aug. 2. Among sector funds, that's second only to health care, according to

Morningstar

. Healthy earnings and improved cash flow have certainly helped the industry. But more importantly, real estate funds have benefited from the fact that

REITs have been unloved for so long, and the undervalued sector looked appealing for investors fearing just about everything else.

"What has changed is the volatility of the market," says Arthur Hurley, portfolio manager of the

(SSREX)

State Street Global Advisers Tuckerman Real Estate fund. The $47 million offering is up 31% so far in 2000.

It's not hard to find hot stocks in real estate. In the hotel area,

Starwood Hotels

(HOT)

, up 47% year to date though Aug. 1, and

Host Marriott

(HMT)

is up 46%. Office REITs are also enjoying a boost, with

SL Green

(SLG) - Get Report

, an owner of New York City properties, up 40.4% and

Equity Office Properties

(EOP)

, real estate guru Sam Zell's company, is up 27.7%. Even those specializing in apartments are enjoying a surge, with

AvalonBay Communities

(AVB) - Get Report

, a bicoastal luxury apartment developer, up 41.9% and

Essex Property Trust

(ESS) - Get Report

, based on the West Coast, up 49.1%.

Before this year, real estate funds had been mired in a slump. In 1998, they declined 9% as a group. The following year the funds went down 3.5%. But the volatility in technology and other high-growth sectors has moved some investors over to the REIT camp.

"For a long time there were sexier alternatives in the market," says Damon Andres, portfolio manager of the $110 million

(DPREX) - Get Report

Delaware REIT fund. "Momentum investing seemed to work, and there was overconfidence. That's changed."

Not only that, REITs have also displayed some compelling reasons on their own. They've had strong earnings growth. Of 70 REITs coming out with second-quarter earnings, more than half beat estimates.

Falling loan prices in anticipation that the

Federal Reserve is done raising interest rates have helped recently because that lowers the REITs' cost of capital. Rising mortgage rates might hurt office properties and mall developers but have been a boon during the past year for multifamily properties. Tenants stay in their apartments longer while they squirrel away money for a down payment.

At the beginning of the year, the stock prices that REITs were selling at were a discount of about 25% to 35% of the value of their properties. "They became a tremendous value," says Jim Throwbridge, portfolio manager of

(IARAX) - Get Report

Aim Advisers Real Estate fund. Now they are trading at about a 5% discount, though Throwbridge estimates that they could reach a

premium of 10%.

Of course, when investors see real estate funds up so much, some of them get nervous.

"REITs don't move like this," says Sam Jones, a financial adviser with

R.E. Jones

in Denver who uses quantitative models to make sector bets. Since June, he has been in real estate, which didn't emerge as a leader until the second quarter. The last time Jones was investing in REITs was three years ago. In 1997, real estate's last boom year, REITs were posting high double-digit returns. Many were trading at a premium in excess of 25% in the value of their underlying real estate and attracted leagues of momentum investors.

"REITs are not growth stocks," says Hurley of State Street. "Having investors looking for momentum

getting into the sector is not a solid investor group."

This time the euphoria might be different, real estate observers say. First, the stocks have recently come off a bottom. And three years ago there was concern about overbuilding, which didn't pan out. Demand for properties so far continues to outstrip supply.

Still, portfolio managers aren't ready to jump into the entire sector. While hotels, offices and apartments are favorites among investors, more than a few are shying away from nursing home operators, home builders and self-storage.

"When you look at something like office properties that have stable cash flows, health care just isn't as attractive to investors," says Andres of Delaware.

The political risk associated with Medicare reimbursement rates keeps some investors at bay. The government sets the rates that it will reimburse hospitals and nursing homes, and the hospital operators have limited ability to negotiate them.

Even those few setbacks don't dissuade investors. Jones and others still see more room for gains before the year is out.

Louis Stanasolovich, financial planner with

Legend Financial

in Pittsburgh, says he keeps about 5% to 10% of clients' money in real estate for diversification. Real estate, because of its value nature, acts like a buffer for more high charging growth stocks.

But even proponents of real estate such as Stanasolovich don't think the market can continue to keep up the torrid pace. "I don't expect in the next 12 to 24 months that we'll see 10% to 15% returns," Stanasolovich says. "It's not tech."