The Other Real-Estate Boom:
REITS Are Up More Than 30%

Investors, painfully aware that the housing market is in the doldrums, may be surprised to learn that some of this year's best stock performers have been real-estate companies.

Yes, home builders have been basement dwellers and some lenders look shaky. But real-estate investment trusts are up more than 30% year-to-date, and the real-estate mutual funds that invest in them are hitting home runs, according to fund-tracker Morningstar. REITs, as they are known, are tax-advantaged stocks that concentrate on the commercial side of the real-estate business and distribute the lion's share of profits to shareholders through dividends. They deal in office parks, shopping malls and apartment buildings -- rather than McMansions.

Commercial construction has been booming after a protracted slump earlier this decade. During the first half of the year, commercial building grew at a 15% annual rate, according to Commerce Department data. The sector contracted in 2001, 2002 and 2003, so likely isn't as overdone as the residential side. Overbuilding would be a big problem for REITs because that would drive down rents, their primary source of income.

Low interest rates help, and the private-equity boom has added steam to some REIT players, luring investors who want to bet on the next fat deal. REIT mergers and acquisitions have hit a record $117 billion in 2006, according to the National Association of Real Estate Investment Trusts, soaring from $30 billion for the past two years combined.

But has the REIT run gotten overdone? One recent event raises the question: industry icon Sam Zell's $20 billion sale of Equity Office Properties Trust, the REIT he took public in 1997, to Blackstone Group. If Mr. Zell is selling, perhaps that says something about the outlook for the sector as a whole.

REITs look pricey by other measures. Consider one metric of how much investors are paying for every dollar of the cash REITs produce -- called price-to-adjusted funds from operations. It stands at 26, well above the group's historic average of 15, according to Green Street Advisors, a real-estate research firm.

"REIT valuations are just so high relative to other assets that the sector as a whole is really susceptible to a shift in investor sentiment," says Christopher Mayer, a real-estate professor at Columbia University and a board member of Oak Hill REIT Management, a hedge fund.

"Everything has to work right in the wonderful world of real estate that we live in," says Sam Lieber, Alpine Mutual Funds president.

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