From countless territorial wars through the centuries to the image of Scarlett O'Hara clutching a piece of her battered plantation's dirt with steadfast determination, real estate has long held an undeniable, almost visceral, appeal. To Robert Steers, chairman of Cohen & Steers Capital Management, the same might be said for real estate investment trusts, or REITs.

Fifteen years ago, when Steers and partner Martin Cohen founded their Manhattan-based firm specializing in these securities, the notion of investing in real estate through public markets was virtually unheard of by most people. Today, with more than $5 billion under management through its mutual funds and institutional investors, Steers and Cohen are considered by many to be the deans of REIT investing.

But even Steers would admit that you can't live in a stock, show it off to neighbors or build a shopping center on it. What you can do with REITs is diversify a portfolio-a task that has become increasingly difficult in a global economy in which established stock markets often move in step with the United States. In recent years, this game of follow the leader has led many investors in lemminglike fashion off a cliff.

"International investing, which was once hailed as the great diversifier, has failed miserably in that mission," says Steers. "The correlation between our market and others is actually quite high."

By contrast, REITs display a remarkable ability to zig when the market zags. According to a recent study from Ibbotson Associates and the National Association for Real Estate Investment Trusts (NAREIT), the correlation between REIT stocks and the broader U.S. equity market has weakened considerably over the last 30 years. Specifically, the correlation of REIT returns has declined 65% for small stocks since the 1970s (from .74 to .26) and 61% for stocks of large companies (from .64 to .25).

Staying true to their contrarian nature, REITs last year enjoyed a sharp upturn as investors abandoned tech stocks and other growth issues and flocked to the relative safety of equities that actually produced dividends. With the vast majority of stocks producing little or no dividends and their prices sinking like stones, the 7%-plus yields of REITs that once drew little more than yawns looked positively juicy.

As REIT fans already may know, these securities produce high dividends because they must distribute at least 90% of their taxable income in the form of shareholder dividends. At times, their yields can rival the income from high-yield bonds. In 2000, those high yields, plus appreciation in the securities, vaulted the NAREIT Composite Index to a gain of nearly 26%. As of August 31, the index was up 14.35% so far in 2001.

Just a couple of years ago, the picture looked much grimmer. After two exceptionally strong years in 1996 and 1997, REIT prices began contracting in 1998. The downturn was exacerbated later in the year after the Russian debt crisis, and the ensuing stock market meltdown prompted investors to flee cyclical stocks such as REITs. By the end of that year, the NAREIT Composite Index, a benchmark for REIT performance, fell nearly 19%. In 1999, as investors ignored REITs in favor of technology stocks, that index fell another 6.48%.

In the process of becoming the new darlings of the stock market, REITs have gotten more expensive by many measures. By the end of 1997, REITs as a group traded at an average of 25% above the value of their assets. By mid-1999, after performing poorly for 18 months, they were trading at an average of 15% below their asset values.

Today, while REITs are trading at a more modest discount of around 5%, Steers believes they have more upside room. "People should pay less attention to underlying asset values and more to underlying cash flows, which remain strong," he says. "Since 1986, REITs have traded at an average of 12 times cash flow. Today, they trade at about nine times cash flow. That tells me they are still cheap." With REITs paying out just 60% of their cash flow as dividends, he adds, "an unprecedented decline in earnings would have to occur before these dividends could possibly be in jeopardy."

Reaction To Disaster

The question now is whether that resilience can survive what some fear will become an extended bear market. The September 11 terrorist destruction of the World Trade Center and severe damage at the Pentagon sent stocks into a tailspin in the period immediately following the disaster, and REITs were not spared.

Cohen & Steers Realty Shares, which has a strong presence in several REITs that concentrate in the New York area office market, fell 7.86% in the week ending September 21. That downturn, however, was considerably less severe than the reverberations felt in other areas of the market. During the same period, the S&P 500 Index plummeted nearly 12%, and the Dow dropped 14%.

The news was mixed for fund holdings. Brookfield Properties owned several buildings that were severely damaged in the collapse. Steers says that management has assured shareholders that the structural problems are fixable within a two-month time frame, and damages are fully insured. From a monetary perspective, he calls the event "a short-term neutral" for the company.

However, with millions of square feet of Class A office space in ruin, companies will be scrambling to find new quarters. Steers believes that two stocks in particular-Vornado Realty Trust and Reckson Associates Realty-will be "far and away the biggest beneficiaries" of the need for office space because they have several new buildings in New York coming online.

"Like many investors, my outlook on the world has darkened since September 11," he says. "But for the most part, REITs will be able to report year-over-year earnings gains in the 7.5% range. Relative to other areas of the market, that looks terrific."

An Uneven Tide

It remains to be seen whether REITs can hold their own at a time when the nation, and the stock market, are still wobbly. What is certain is that not all of them will react the same way in the months and years ahead.

Although many financial advisors know that the performance of real estate investment trusts has been one of the market's few bright spots this year, fewer are aware just how unevenly the stock market tide has lifted the highly segmented real estate sector boats. Lumping all REITs together is akin to saying New York office rents move in the same direction as Florida hotel rates. Yet that's precisely what many investors do.

"REITs are far from a homogenous group," says Steers. "Some specialize in apartments, which usually have one-year leases. Office REITs depend on longer-term leases, so the impact of economic changes is more muted. And you're got hotel REITs, which essentially depend on 24-hour leases. Those are the most cyclical of all."

For most of this year, investors have gravitated to real estate investment trusts that specialize in health care. According to NAREIT, those REITs rose 47.34% in the eight months ending August 31, while office and industrial REITs rose a relatively modest 6.34% over the period.

Those trends are reflected in the recent performance of the Cohen & Steers Realty Fund, the firm's oldest and largest fund, and the younger, smaller Cohen & Steers Equity Income Fund. The realty fund, which focuses on larger, more established real estate investment trusts and has a strong presence in the office sector, rose 1.75% in the one-year period ending September 21. Equity Income, which concentrates on smaller REITs, many of them in the health care sector, rose 8.93%.

"Smaller REITs have higher yields than larger ones, and that attracted a lot of investors," says Steers. "They have opted for current return over prospects for growth." Larger REITs sport yields in the 6.5% range, while smaller ones yield 8% or more, he says.

But, he adds, several trends point to the office sector taking the lead in the latter part of the year. Many larger companies are consolidating, creating industry giants that have the potential to dominate the real estate business. The relative underperformance of larger REITs in the beginning of the year has made their valuations more compelling. As investors continue to seek out REITs, "companies with greater size and liquidity are likely to be the primary targets."