Real estate stocks: It may still be too early to buy

— -- Q: Why are shares of real-estate investment trusts (REITS) getting hurt so badly?

A: Real-estate investment trusts are on the front line of the financial crisis.

REITs own and control income-producing real estate. That includes everything from shopping centers and office buildings to self-storage businesses. And that's been a dangerous neighborhood to hang out in.

The SNL U.S. REIT equity index, which tracks the industry's stocks, has fallen roughly 55% since Feb. 2008. That decline is better than the 70% decline of the SNL Bank Index, but still much worse than the 40% decline by the broad Standard & Poor's 500 index. The downdraft is caused by several things, including:

• The slowdown in economic activity.Vacancies are on the rise, especially in retail and office buildings. And vacancies are a big reason for the decline in REIT shares.

• Lack of capital. Jason Lail, real estate analyst at SNL Financial, says there's virtually no capital available for REITs to borrow to buy properties. At the same time, there's no appetite for the REITs to sell distressed properties, sticking them with poor-performing assets.

• Changes in tax law. A new Internal Revenue Service rule has upended one of the long-standing tenets of REIT investing. Traditionally, REITs are required to return 90% of their profit to investors in the form of a cash dividend. The new rule, through 2009, allows REITs to pay 90% of their dividend in stock. That's a big disappointment for investors. Not only are they not getting the cash they might have expected, but they're also seeing their stock positions diluted by the additional shares, Lail says. Meanwhile, a growing number of REITs are cutting or suspending their dividends.

• The 2007 bubble in REIT shares. Many private equity firms used borrowed money to bid up prices of REIT stocks. That pushed REIT prices above the value of their assets by a wide margin.

When will things get better? Prices of REITs are now 40% below the companies' projected asset values. That's a positive.