Some see bargains but others warn about getting carried away

But are they being overly optimistic? After all, a typical REIT mutual-fund is down more than 7% so far this year. That makes it the worst performing domestic stock category in 2007 by a wide margin, according to Morningstar Inc.

"Opportunities for long-term investors who are underweight real estate have certainly opened in recent months," said Jim Trowbridge, co-manager of AIM Global Real Estate Fund. Bargains are relative, however. Even after this year's dismal performance, a typical REIT fund has produced an average annualized return close to 20% in the past five years. In the same amount of time, an average U.S. diversified large-cap core fund has generated only about half as much.
As a result, REIT funds aren't trading at the low end of their historic valuations. AIM's Trowbridge estimates that price-earnings ratios for the group are probably about midway between their long-term low and high valuations.

"We're seeing a disconnect now between long-term financial strength of some of these companies and how the market perceives their value," he said. "But we expect volatility to remain with us for awhile. It's probably going to continue to be a fluid situation."
In the short-term, credit worries are still a concern in real estate markets. As loan standards tighten and fewer speculators can borrow money to invest in commercial paper, some analysts caution that business-minded REIT investors could turn away in droves.
So far, the subprime meltdown has mainly spread to residential segments. David Copp, co-manager at TIAA-CREF Institutional Real Estate Fund points out that investing in commercial sectors is a lot different than investing in housing.

As a result, he doesn't expect panic among businesses tied to home buying to significantly depress commercial property markets.

"On the margins, some commercial real estate investors are highly leveraged and aren't going to be in the market looking for more properties," Copp said. "But those are mainly undercapitalized, short-term speculators."

The wild card is general macro economic conditions. If those slide faster than anticipated, commercial property demand could weaken.

Discounts to property values

A key metric with valuing real estate stocks is comparing price movements to changes in a firm's operating income. Right now, Copp estimates that those levels show a typical REIT fund's net asset value trading at about a 20% discount. That value is based on how much a portfolio would generate if liquidated on the open market today.

"After this year's sell-off, investors are essentially paying about 80 cents on every dollar for a high-quality REIT fund's underlying assets," Copp said.

Historical averages for the sector show such discounts have reached around 30% against present-day property valuations, he added. "Looking at past cycles, you might be able to buy shares of leading REITs for as low as 70 cents to 75 cents on the dollar. But that's about as low as we're used to seeing in this industry," Copp said.

That's why he believes that fund investors with underweight REIT positions according to their long-term asset allocation plans start considering wading back into the asset class.
So does Trowbridge. "This actually seems to be a pretty opportunistic point for long-term fund investors to selectively start dollar cost averaging into the market," he said.

But check your long-term asset allocation plan, Trowbridge emphasizes. "With the level of volatility in the market now, if you're overweight real estate, you might want to remain fairly cautious," he added.

Showing resilience
The sector has shown some resilience lately. When the crisis in residential lending erupted in July, the average REIT fund's tumble was roughly in line with financial stocks as a whole. But in the past month through last week, an average REIT-related fund has lost less than 1.5% in total returns, according to TrimTabs Investment Research. Stock funds as a group have dropped an average of 4%-plus.

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