August was the cruelest month. After Standard & Poor's downgraded U.S. credit, the stock market swooned for its worst round of bloodletting since the collapse of Lehman Brothers in 2008, prompting fears of a double dip recession.

And real estate investment trusts were not immune to the carnage. Classic REIT names like Vornado, Boston Properties, Simon Properties and Public Storage all saw red arrows and low-single-digit percentage point drops early in the month.
But was it deserved? Perhaps. But perhaps not.

"Real estate." It's the kind of thing people have likely said through clenched teeth in the past couple of years. After all, it was the source of most U.S. financial misery in the 2008 financial meltdown, the well from which we've drawn mostly tears.
Much of this pain came from an extended home building spree, which has led to sinking home values, foreclosures and evictions. But an economy that's been toxic to homeowners has meanwhile been tonic to landlords. Rather than buying houses, after all, Americans are becoming renters.

And though not all real estate is doing well in every city, REIT stocks have benefited from new inflows of equity, cleaned up balance sheets and a constrained supply of quality buildings in gateway cities where it's easier to hike up the rents. Better yet, a lot of them have renegotiated new leases in the last couple of years, giving them better purchase to weather a storm.

That's just some of the happy news for REITs, the companies that buy and manage properties such as retail outlets, malls, office buildings, apartments, health care facilities, etc. But more important to investors is that REITs also are continuing to offer higher yields than bonds in this cash-strapped, low interest-rate era. Real estate investment trusts are legally required to pay out 90% of their taxable income to investors annually. That's one of the reasons global capital has sought them out in hopes of juicing extra yield, a sexy proposition at a time when bonds are paying almost zero. Some investors are even seeing REITs as fixed income alternatives, a source of long-term yields that have kept ahead of inflation.

The promise of total return has sent investors piling in and REIT stocks soaring over the past couple of years. The MSCI U.S. REIT index returned nearly 275% from its trough in March 2009 to the beginning of August 2011. The FTSE/NAREIT equity index was up about 225% for that period. The NAREIT index returned about 27% in both 2009 and 2010 when the S&P 500 index returned just over 23% the former year and 15% in the latter.

This is a far cry from three years ago in 2008, when REITs suffered a staggering fall from grace. Those indexes lost almost half their value that year, despite these securities' vaunted promise of diversification. The SPDR Dow Jones Wilshire ETF REIT exchange-traded fund fell 42% for the year, partly erasing the 328% in returns it had gathered from 2000 to 2006.

But the crisis wasn't due to bad fundamentals like oversupply, say REIT proponents, so much as it was the result of the debacle in the credit markets. REITs are a capital-intensive business that live and die by access to pools of financing, and they suddenly found themselves beached whales with no water-finding no financing from tight-fisted lenders who were working to recapitalize their own balance sheets.

Many REITs had also by that time succumbed to the urge to leverage up (like a lot of other companies and other people, for that matter, in the go-go pre-fall years) and that left them further vulnerable to a crash. Choked with debt, hurt by falling stock prices and without the ability to refinance or to move buildings off their books in a flooded market, many of them were suddenly cash poor and had to cut their sacrosanct dividends.

That distortion has led many people to misunderstand REITs' real strengths and weaknesses, however, say advocates. And three years on, now that construction has stagnated on new buildings, these stocks own space that's in high demand with low cap rates. They are, in other words, benefitting from a classic supply/demand imbalance.