Real-Estate Mutual Funds Are
Still Solid Investment Choices

All the talk about the bursting real-estate bubble has probably scared some investors in high-flying real-estate mutual funds.

Indeed, in August (the most recent data) the sector had outflows of $170 million, after ending 2004 with the most inflows ($4.68 billion) of any fund sector tracked by investment-research firm Lipper. But the reality is many real-estate funds aren't much affected by housing prices. That's because most of their holdings are in real-estate investment trusts, or REITs, which buy commercial property. And that market isn't bubbly.

To be sure, there are some good reasons to be selling real-estate funds right now. For one thing, investors who came to this party early are sitting on some gaudy gains. The average real-estate fund has returned 25.98% annualized over the past three years and 18.53% over the past five, compared with 19.12% and 1.15%, respectively, for all equity funds. What's more, the sentiment that all real estate is in trouble, true or not, might continue to exert some downward pressure. For the short term, the sector may suffer from association.

But, on the whole, the case for real-estate funds is still strong. With the economy on reasonably sound footing, demand for income-producing properties that fuel REITs, like hotels, retail stores and office space, is solid. Moreover, when rates were scraping bottom, many commercial property owners refinanced their mortgages at favorable long-term fixed rates. That has left them in the advantageous position of allocating less of their lease income to mortgage payments. And even if the residential home-buying market continues to sour, that should buoy demand for apartment rentals, an important source of income for many REITs.

This week, we searched for no-load funds whose three- and five-year returns rank in the top 50% of the real-estate fund group. We also demanded the funds carry expense ratios in the bottom 50% of the classification. Finally, we asked each fund be open to new investors, accept minimum initial investments of $5,000 or less, and hold total net assets of $50 million or more.

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