Erika Morphy is co-editor of Debt and Equity Journal, from which this article is excerpted.

Washington, DC—Retail and institutional investors have had their faith in REITs rewarded for the past seven years. That is how long REIT returns have outperformed the broader market, according to data compiled by the National Association of Real Estate Investment Trusts. That record, however, and investors' faith in it, is over.

Nareit reports that the FTSE Nareit All REITs Index delivered a -6.96% total return for the first six months of 2007. This trails returns of the S&P 500 (6.96%), the Dow Jones Industrials (7.59%), the Russell 2000 (6.45%) and the NASDAQ Composite (7.78%). The lodging/resorts sector, with a total return of 2.97%, and the specialty sector, with a total return of 6.61%, outperformed REITs as well.

With those figures now in, it is clear that the ride is over for some investors, at least temporarily. Advisors such as Brad Levin, president of Legacy Wealth Partners in Encino, CA are advising retail investors to stay away from these instruments for the time being. "I would recommend not investing in traded US REIT's right now," he says. "They've appreciated considerably in recent years and have been dropping recently. I expect that to continue as interest rate concerns continue and equity investors rotate to less pricey or risky asset classes."

There are bright spots remaining in the industry, though, Levin adds. "I find international REITs attractive. They're still a very new asset class and institutional investors are allocating more to this sector. There have been a number of countries recently adopting the REIT structure similar to the US, which is creating more of an investment demand."

Levin also says commercial properties and apartments are very attractive right now. "Individuals can and should invest in apartments and commercial properties through either non-traded REITs or limited partnerships. Non-traded REITs offer investors purer real estate exposure without the volatility associated with listed securities. They have done very well in recent years. There are some great limited partnership investment opportunities where retail investors can gain access to institutional quality assets."

Harold Levine, tax attorney and partner with Herrick Feinstein in New York City is more sanguine about the recent statistics. "Lagging returns shouldn't be viewed as a negative. REITs have--over the long term--outperformed the markets."

To be sure, REITs' long term record remains unsurpassed: they have beaten the other major equity market benchmarks in longer-term performance, delivering not just higher returns but lower volatility as well. Compound annual total returns of the FTSE Nareit All REITs Index have outperformed the other equity market benchmarks for the past three-, five-, 10- and 15-year periods ended June 30, Nareit points out.

Also, the All REITs Index's Sharpe Ratio, which measures returns relative to volatility, was 10% better than the S&P 500's Sharpe Ratio during the past 30 years and 12% better than the S&P 500's during the past 20-year period, ended June 30.

Levine goes on to note that after any downward spurt, say two years, REITs have rebounded and sustained huge growth. "Owning REITs is a must for any pension plan or fund in a diversified portfolio. With less and less REITs out there due to privatization and consolidation the investment needs to go somewhere--and this should help sustain REIT values." Obviously, private money thinks REITs are trading at a discount, he adds, pointing to all the private deals over the past few years. "This should bode well for REITs rebounding and catching up to the broader markets," he adds.

Doug Snyder, partner in the Los Angeles office of the real estate law firm Cox Castle & Nicholson agrees that the long term prospects for the REIT market should be based on the fundamental value in REIT assets--that is, office buildings, retail projects, hospitality projects, apartments and other properties that are owned by REITs.

"I am not aware of any changes in these fundamental values that would justify a depression in REIT prices," Snyder adds. "Most experts agree that REIT returns have lagged behind broad market returns this year because of the sensitivity of REIT values to fluctuations in interest rates. 2007 has seen greater uncertainty in interest rate trends than recent years, as well as a cross-over effect from the residential sub-prime lending market--even though most public REITs are not in this sub-prime market."

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