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THE LAST TIME

we looked at real-estate mutual funds, a little less than six months ago,

whether this fund category was ripe for a turnaround. After all, there were some broad economic concerns back then, like a credit crunch and cash-strapped consumers. However, real-estate funds looked cheap and there were sectors that had the potential to do well regardless of what happened across the country.

That call seems prescient now. Real-estate funds posted a disappointing 14.8% loss in 2007, and many fans of this sector looked overseas for their exposure. However, at the tail end of the first-quarter earnings season they were up 7.2%, according to Lipper. They have slipped since then thanks, in part, to uncertain guidance going forward and fears that $4-a-gallon gasoline would keep consumers away from malls. But the group's 2.7% average return year to date through Thursday is still second only to fund categories like gold and natural resources that have run up in the recent commodity bull market.

With that in mind, we devoted this week's fund screen to the real-estate sector. There are 366 real-estate funds and share classes listed in our Lipper database. That's one of the smallest groups we start with all year. And after two weeks of looking at load funds, we return to knocking them out of contention this time around. That got rid of 326 offerings. We narrowed our finalists further by looking for top-tier performers that also charged low annual fees. We were left with just seven funds.

Real estate has become a mainstay in many portfolios. Advisors like it because it's a noncorrelated asset class. In other words, as stocks go down real estate tends to rise, and vice versa. Typically, these funds invest in real estate investment trusts, or REITs, which are exchange-traded and usually own stakes in dozens of shopping malls, office parks, apartment buildings or even hospital properties. To avoid taxation at the corporate level, REITs pass through almost all of their profits to shareholders, leading to big yields that attract investors looking for income. A real-estate fund's position size can range from a few percentage points in a portfolio to as much as 10%.

"We have always held a place for REITs [in our clients' portfolios]," says Joe Birkofer, principal at Legacy Asset Management in Houston. He's been adding to his positions lately. "We continue to be bullish," he says.

The comeback of the last few months can be attributed to several factors. While the category isn't immune to some of the macroeconomic issues plaguing other industries, some REITs have weathered the storm quite well and, from a valuation standpoint, now seem to be oversold. Occupancy rates at office parks and outlet centers have decreased a bit, but they still remain healthy and rents have been inching up. And all those consumers who would have qualified for mortgages just 18 months ago are now renting instead, helping apartment complexes avoid vacancies. Even at shopping malls, where high gas prices should have cut into visits by consumers, tenant closings or bankruptcies are not as bad as once feared (although certain parts of the country have been hit harder than others).

That's not to say, though, that industry is in the clear. If consumers are forced to pay $4 a gallon for gas the entire summer it will certainly impact shopping malls and lodging properties. But the reason why this sector is getting some advisors and analysts excited is that it tends to be a leading economic indicator. Why else would a company lease more office space or open new stores if its executives weren't optimistic about the future?

One fund that made our cut is CGM Realty. This highflier returned 28.6% over the last year, tops among its competitors, according to Morningstar. But there's a reason for that good performance. Ken Heebner, a well-respected manager known for his rapid trading style, has filled this concentrated portfolio of 19 stocks with companies that are more closely aligned with the commodities sector than to real estate. "Investors need to check under the hood before picking up CGM Realty," warned Morningstar's Wenli Tan in her latest write-up of the fund. Heebner's top two holdings, which account for 25% of the fund, are Mosaic and Potash Corp. of Saskatchewan, two firms that make fertilizer and other agricultural products.

A more traditional offering is T. Rowe Price Real Estate. This $2.3 billion fund has been run by David Lee since 1997. It's in the category's top quintile over the previous decade and, at a 0.73% annual expense ratio, it charges some of the lowest fees around. Two real-estate equities he owns at the moment are Gaylord Entertainment and Macerich.

Macerich, an owner of malls in Arizona, California, the Washington, D.C. area and New York City, among other places, reported a 13% increase in funds from operation per share a key cash-flow metric for REITs during its first quarter. It signed 336,000 square feet of specialty-store leases at average rents of $44.71 per square foot, a 24% increase over the expiring rental agreements.

Gaylord, famous as the owner of the Grand Ole Opry, saw its share price hammered last year over several concerns, including whether cash-strapped consumers would be able to afford to drive to visit some of its entertainment properties. Lee, though, thinks the company's conference business, especially with a new hotel and convention center outside Washington, D.C., will remain strong. "[The stock] didn't warrant such a heavy correction."

The Criteria

The real-estate funds on our list were open to new investors, required a minimum investment under $5,000 and charged an annual expense ratio less than 1.5%. They also had performance track records that put them in the top 50% of the category over the trailing three- and five-year time periods. Finally, after two weeks of looking at load funds, we have returned to disqualifying any funds that charge these fees.

Also See:

• More Funds That Are Worth Their Weighty Loads

• Low-Cost Load Funds Make Sense for Some

• Consistent Returns Can Reveal Good Funds

See the Fund Screen Table

Data as of May 22, 2008.

Real Estate Screen Recipe

• More Funds That Are Worth Their Weighty Loads

• Low-Cost Load Funds Make Sense for Some

• Consistent Returns Can Reveal Good Funds