REITs get mixed investment review amid rise in rates.

Real estate investment trusts have been under fire on Wall Street, based on fears of rising interest rates, but investors are finding that not all REITs are created equal.

Rising interest rates could have a positive effect on office, industrial and mall REITs because most tenant leases require rents to rise when inflation goes up.

"To the extent that there's inflation in the picture, many properties may have that already built into their leases," said Paul Adornato, an analyst at Harris Nesbitt Corp.

Adornato and Richard Anderson, another Harris Nesbitt analyst, initiated coverage last week of 39 publicly-traded REITs, including four in Los Angeles--Arden Realty Inc., Health Care Property Investors, PS Business Parks Inc. and Public Storage Inc.

The four local REITs all received a "neutral" rating.

Environment at risk

"We think the environment is definitely at risk due to the interest-rate scenario, but we don't think there's another sector out there that will take a bite out of REITs," Adornato said.

In the early 1990s, REITs lost popularity when interest rates rose and investors started pouring into technology stocks.

REITs have outperformed most stock market averages year-to-date, with an 11 percent total return, compared to 2 percent for the Standard & Poor's 500 Index.

But analysts caution that REITs are primed for a slowdown precisely because they have been among the strongest stock market performers of the last few years. Morgan Stanley's REIT index is up about 6 percent this year, after rising more than 30 percent each year in 2003 and 2004.

Institutional investors jumped into the space when interest rates plummeted, as a way to play rising real estate values nationwide, since REITs buy all types of income-producing properties, including apartment complexes, office buildings, mobile home parks and shopping malls.

Recently recovered

However, the REIT market took a hit in July when Morgan Stanley cautioned that valuations made REITs susceptible to any rise in interest rates on U.S. Treasuries. Morgan Stanley downgraded ratings on six REITS and raised ratings on four, including PS Business Parks.

But the overall comments sparked a sell-off on Wall Street from which REITs have only recently recovered.

Several REIT analysts believe a housing bubble exists in much of the country and that REITs will track home prices, which could fall between l0 percent and 20 percent as interest rates rise.

"On a fundamental level, the appreciation of real estate values has been a difficult puzzle to solve," wrote Raymond Mathis, an analyst with Standard & Poor's, in a recent report.

"Though we are neutral as a whole on the industry, we have become increasingly bearish of late."