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) -- Real estate mutual funds, ground zero for the financial meltdown and housing bust, returned 33% in the past three months, ranking as the top-performing category, according to Morningstar.

As a result, real estate stocks no longer sell at hefty discounts. Still, property funds show an attractive balance between risk and return for investors who want to get back into real estate. The industry has bottomed, or at least isn't declining at the same pace as the past 18 months, reports have suggested. Some of the best bets may be

AIM Real Estate



Neuberger Berman Real Estate



Alpine Realty Income & Growth



Investors ought to view real estate funds as long-term investments, not as vehicles to make a quick buck during boom times. The funds currently yield 3.6%, compared with 2.1% for the

S&P 500 Index

. During the past decade, real estate funds have returned 7.8%, while the S&P 500 has lost value.

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The value of real estate as a tool for diversification was highlighted when Internet highfliers crashed in 2000. While the S&P 500 dropped 9% that year, real estate funds gained 27%. Having been burned by stocks with sketchy earnings, investors raced to buy real estate, which appeared to be a solid asset that always retained some value.

Seeing how real estate performed during the tech downturn, investors from around the world began snapping up commercial real estate and real estate investment trusts, or REITs, which hold portfolios of offices, apartments or other properties. Aggressive private investors borrowed heavily and bid up prices to record levels.

The great real estate bull market ended in 2007 as the first signs of the credit crisis emerged. During 2007 and 2008, real estate funds dropped 50%, trailing the S&P 500 by 14 percentage points. As financial problems worsened, plenty of real estate companies announced dividend cuts. Analysts said some REITs could go bust.

But after this year's stock-market rebound began in March, REITs rallied as worries about dividend cuts and bankruptcies receded.

AIM Real Estate proved to be resilient during the downturn, dropping 24% over the past year, beating 82% of its peers. The fund has returned 10% annually in the past 10 years.

AIM holds a diversified collection of REITs, including companies that specialize in offices, apartments and malls. In recent years, the fund has turned defensive, sticking with high-quality REITs. The strategy has helped performance. "REITs with better balance sheets and fundamentals did relatively well during the downturn," manager Paul Curbo says.

A top holding is

Simon Property Group


, a big owner of quality shopping malls. Like all mall owners, Simon is faced with weakening occupancy rates. But the REIT is stronger than most, maintaining long-term leases with known national chains. Holding $2.6 billion in cash, the REIT should be able to survive the downturn and begin making bargain acquisitions as distressed properties come on the market, Curbo says.

AIM also holds

Boston Properties


, which owns high-quality offices in Boston, New York and Washington. While those markets are suffering from falling rents, they are in relatively sound shape and should rebound when the economy recovers, the manager says.

Another top performer is Neuberger Berman Real Estate, which has lost 21% of its value in the past year, less than 91% of its competitors. The fund has excelled by emphasizing REITs that have reported relatively steady revenue during the recession. A favorite holding is

Digital Realty Trust


, which owns properties that house servers and other equipment used by corporate data centers. Since Internet traffic has continued to grow throughout the recession, demand for data centers has climbed, and Digital Realty has reported growing sales and earnings.

Another holding that has shown revenue growth is

Alexandria Real Estate


, which owns properties that house research laboratories. Much of the space goes to universities and pharmaceutical companies, reliable tenants that tend to sign long-term leases.

Investors seeking a rich yield can consider Alpine Realty Income & Growth, which currently pays 8%. In addition, manager Robert Gadsden is now favoring preferred shares. Those yield, on average, 9%.

Resembling bonds that pay fixed yields, preferred shares are safer than common shares. During bankruptcies, companies must pay preferred shareholders before giving dividends to owners of common stock. "During the past 18 months, we shifted to preferreds to increase the safety of the portfolio," Gadsden says.

Alpine owns the preferreds of

Public Storage


, a big owner of self-storage facilities. Boasting a strong balance sheet, the company has the ability to acquire competitors and gain market share when the recession ends, the manager says.

Stan Luxenberg is a freelance writer who specializes in mutual funds and investing. He was formerly executive editor of Individual Investor magazine.