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This REIT Rally Could Be for Real

There are signs the current upturn won't fizzle like last year's.

REITs-yckw This REIT Rally Could Be for Real By Anne Kates Smith There are signs the current upturn won't fizzle like last year's.

Shhhh. Don't tell anyone, but real estate investment trusts, commonly known as REITs, have crept quietly back into the ballgame. Could it be that the

Chicago Cubs

of investing are about to have a

Yankees

season?

Look at the scorecard. So far this year, equity REITs -- publicly traded portfolios of commercial properties -- are up 10% on average. Real estate mutual funds are up nearly 8%, according to

Lipper

, making them the third-best performing sector group, behind biotech and natural resources, and way ahead of diversified equity funds, down 4.4%.

REITs are supposed to go up, of course, because the market overall is down. With only a 0.3% correlation with the

S&P 500

index (a perfect correlation would be 1.0), REITs are supposed to zig when the market zags. Thanks to their generous 7% yields, REITs also are a defensive play, like utilities stocks (up 19% this year). And because REITs are, essentially, hard assets, they are inflation beneficiaries, like energy (up 8.6%).

So it would seem REITs are a natural for the current climate. Still, "no one knows that," laments Martin Cohen, co-manager of the

(CSRSX) - Get Cohen & Steers Realty Shares L Report

Cohen & Steers Realty and

(CSEIX) - Get Cohen & Steers Real Estate Sec A Report

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Cohen & Steers Equity Income funds. Well, actually, someone knows, because after suffering nine straight months of net redemptions, real estate mutual funds saw a net $160 million flow-in during April, according to Boston fund consultant

Financial Research

. Assets had fallen to $7.59 billion from a peak of $13.1 billion at December 1997.

But here's the million dollar question: Will a REIT rally have legs this time? Or will it collapse after a month or two like the one last spring? Despite periodic rumors of a revival, REITs themselves have delivered an abysmal 1.83% a year to investors over the past three years. REIT funds have fared even worse, delivering 1.3%.

So why am I glad I never got around to selling my REIT fund?

Because, as Cohen says, "If there was ever a time for a turn, this is it.You can't find an apartment. You can't find office space. Shopping centers are crowded, retailers are strong. There are no problems and no prospects of a problem -- there's no overbuilding. We've seen the worst decline ever when the fundamentals didn't justify it."

In fact, Kenneth Heebner, manager of the

(CGMRX) - Get CGM Realty Report

CGM Realty fund, thinks the fundamentals are about to improve in a big way. "Inflation will be a significant negative surprise the next year -- much higher than anyone thinks," he predicts. That, of course, would be great news for his real estate fund, up 8.4% so far this year. "I am hopeful that this is the year my turtle will become a hare," he says.

Even

Alan Greenspan

is doing his part to bolster REITs. Most actually benefit when interest rates rise. Higher borrowing costs keep builders from adding new supply. And the ranks of apartment dwellers swell as higher mortgage rates make homes less affordable. The one exception: retail REITs, because they'll suffer as soon as the economy slows enough to trim consumer spending.

Money manager Art Micheletti at

Bailard, Biehl & Kaiser

in Foster City, Calif., has 20% of his model portfolio in real estate, at the top of the firm's 10% to 20% range. Micheletti's U.S. stock allocation, meanwhile, is down from 40% normally to 32%. "If you're concerned about stocks, REITs are a good place to hide out," he says. And Micheletti is concerned. He thinks stocks are still 20% to 25% overvalued, with tech stocks selling for 40% to 50% more than what they deserve.

Sheldon Jacobs, publisher of

The No-Load Fund Investor

newsletter, is considering substituting REITs for the utilities portion of his portfolios. "Even with modest capital gains, you're in double-digit" returns, he says. Funds on his recommended list include the

(VGSIX) - Get Vanguard Real Estate Index Inv Report

Vanguard REIT Index,

(FRESX) - Get Fidelity Real Estate Investment Report

Fidelity Real Estate Investment,

(CREEX) - Get Columbia Real Estate Equity Instl Report

Columbia Real Estate Equity and

(TRREX) - Get T. Rowe Price Real Estate Report

T. Rowe Price Real Estate.

Investors who buy REITs now may be coming late to the party, cautions

PaineWebber

analyst Stuart Seeley. REITs are trading about 10% below the value of the assets in their portfolios, he says, up from a low of about a 25% below net asset value in March. Watch for a flood of stock offerings when REIT prices reach net asset value -- a perennial problem in the industry that tends to snuff out rallies.

Still, Seeley sees a "respectable" 8% to 12% return from REITs over the next year, with most of that coming from dividends. Of the 35 REITs PaineWebber follows, five are rated buy:

Kimico Realty

(KIM) - Get Kimco Realty Corporation Report

,

Essex Property Trust

(ESS) - Get Essex Property Trust, Inc. Report

,

Duke-Weeks Realty

(DRE) - Get Duke Realty Corporation Report

,

Equity Office Properties

(EOP)

and

AIMCO

(AIV) - Get Apartment Investment & Management Co Class A Report

. (PaineWebber has investment banking relationships with all but Kimco.)

PaineWebber isn't the only one eyeing REITs. Mergers and acquisitions are on the rise, and by fund manager Cohen's count, more than 60 real estate companies and REITs have been buying their own shares.

So even if it turns out that most of the home runs were hit in spring training this year, it seems as though the "smart money" sees at least a base hit or two in the REIT market.

Now, if I could just be sure which inning we're in.Anne Kates Smith is a senior editor at U.S. News & World Report in Washington. At time of publication, Smith owned shares of the Fidelity Real Estate Investment fund, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks or funds.

Anne Kates Smith is a senior editor at U.S. News & World Report in Washington. At time of publication, Smith owned shares of the Fidelity Real Estate Investment fund, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks or funds.