But its fundamentals still make the sector attractive.

How long will the string of positive returns last for real estate investment trusts?

REITs have grown at double-digit rates over the past three years. But some analysts say that real estate funds, at best, will perform in line with the market this year.

David Schulman, analyst with Lehman Brothers in New York, estimates REITs will return about 3% in 2003. The reason: The commercial real estate market is in a double bind. If the economy weakens, vacancy rates will rise from already high levels. Even if the economy improves, real estate still tends to lag the economy. Rising property taxes and soft demand for office and apartment rentals already are causing some REITs to cut dividends.

A Merrill Lynch report recently warned that dividend coverage ratios, on average, are starting to decline. Almost half of the 48 REITs followed by Merrill Lynch have coverage ratios that could be squeezed if economic growth is less than expected. The report says REIT earnings will decline this year. The office and apartment sectors have been hurt by high vacancies and declining rents. The hotel sector is volatile and vulnerable. Malls and shopping centers are the bright spots.

Industrywide, however, the National Association of Real Estate Investment Trusts reports that 89% of REITs have raised their dividend payouts since the third quarter of last year, and REITs still are yielding around 7%.

Meanwhile Milton Ezrati, senior economic strategist for Lord, Abbett & Co. in Jersey City, N.J., says REITs may have problems increasing their dividends unless the economy strengthens noticeably. Late last year, for example, Post Properties, a large apartment REIT, cut its dividend 50% to $1.80 due to problems in the rental market.

On the plus side, a survey by Pricewaterhouse-Coopers revealed that institutional investors favor high-quality properties with strong balance sheets and cash flow. They want to invest in office buildings located in the central business districts of New York, Chicago, Los Angeles, Philadelphia and Washington. The reason: Offices in these areas have diversified tenants. Rents and vacancies in these markets also are more stable than in other areas of the country.

The survey also revealed that real estate investors still are optimistic about regional malls and shopping centers. Last year, regional malls were top performers in the commercial real estate market. Mall REITs should perform well if the economy improves.

Leo Wells, president of the Wells Real Estate Funds in Atlanta, says some REITs have cut dividends, but he sees continued growth in most rental markets. The strongest REITs, for example, are not leveraged and have high-quality tenants that carry investment-grade ratings.

"All REITs are not created equal," Wells says. "You have to look inside the REITs. What is the quality of the tenants? How much leverage is being used? Are the properties diversified by tenants, industry and expiration? The key is to own properties that deal with investment-grade-rated tenants."

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