It would make sense that in a flourishing industry, real estate investment trusts would be sure-fire financial winners, right? Wrong.

While REITs are far from dead, industry indexes report depressing earnings for the investment funds. According to Morgan Stanley's REIT index, stocks have dropped 9.5% year-to-date, and 4.5% since the end of May.

Not surprisingly, many REIT managers blame poor performance on unrealistic goals set by analysts, and complain that if REITs fail to meet expectations they are unfairly characterized. Many REIT companies also are wondering if, or when, analysts plan to lower their projections.

Because so many REITs rely on acquisitions to fuel growth, one reason returns are down can be traced to soaring real estate prices, which reflect the otherwise vibrant economy of the '90s. Ironically, some REIT managers may be compounding the problem by overspending on property to justify short-term gains while potentially harming long-term goals.

Still, some experts predict a rebound in share prices as bargain hunters troll the NASDAQ for deals. Another factor helping to stabilize the market is the emergence of more development-based REITs, which are less affected by fluctuating real estate prices.

"There are strengths and weaknesses to each type of REIT," explains Jay Leupp, managing director and senior real estate equity analyst for San Francisco-based BancAmerica/Robertson Stephens. "On the benefits side, new development should generate higher returns, but the drawback is new development carries significantly higher risk."

Once thought to be the answer to the acquisition/development dilemma, paired-shared REITs are now facing increasing scrutiny from the Justice Department.

While legislation to curtail new paired-shared formations has not been enacted, Leupp thinks it's only a matter of time before Congress acts.

"Eventually, I think paired-shared REITs will be restricted, but I don't think it will affect current operations. It will probably happen in the next 12 months, although I think it will be later rather than sooner as it's an election year and politicians are too busy running for office to get much done," Leupp laughs.

Veteran analyst Jay Leupp also explains why golf is good for the real estate game and how fundamental real estate principals will determine the future of the market.

Q: At the moment, what section of the real estate market is driving REIT growth? At the present time, the greatest amount of growth is probably occurring in the office sector simply because, historically, it was the sector that had little exposure, and so we've seen the greatest amount of market capitalization growth. In other words, the size of new companies in the office sector in the past 24 months has grown and there is still room to grow. Really, the same fundamentals driving increases in real estate values-job growth and income growth-are creating new demand for office space, for industrial space and for apartments.

Q: Can you pinpoint a sector that will be the catalyst for future REIT growth? In the future, I think you will see significant growth in the specialty areas, again because, one of the reasons the office sector has grown so much is that there is very little penetration there.

I don't see any one sector actually being the driving force in the long-term growth of the REIT universe. In the short term, it's really going to be a function of underlying fundamentals in a particular sector that will drive growth in that area. In other words, if we get to a period of significant demand for say, new retail space, you're going to see the REIT sector expand in space accordingly.

Remember, REITs tend to be a forward indicator of real estate fundamentals, the stocks tend to move in advance of real estate fundamentals improving.

Q: Since you've identified specialized REITs as a source of future growth, name some of the sectors most promising niches. Golf courses are very promising. Currently, there are only three REITs that invest in golf courses and there are more than 15,000 golf courses in the United States. I think the most promising REIT in the golf course sector is Golf Trust of America, traded as GTA. Collectively, GTA controls less than 200 courses, and they also will provide some of the most significant avenues for growth in the sector. Long term, there is a considerable amount of consolidation that will continue to take place in the golf sector.

Q: Of course, there must be a downside to the specialized REIT market. What is it? There is an underperforming REIT niche. There is potential for significant growth in the automobile dealership sector but, to date, the only REIT in that sector that exists, Capital Automotive REIT, CARS, has been a disappointment. It is currently trading below its initial public offering price of $15. This also is a sector the needs considerable consolidation, and I believe there will be other new public players that will be better operators. To date, CARS is the only one, and its year-to-date performance has been a disappointment in that it traded up to $19 31/44, and now is trading at $14 11/416. So it has been a disappointment for IPO investors thus far.

Q: Should the pace and scale of consolidation among REIT companies be a source of concern for investors? No, actually the pace of consolidation has accelerated significantly over the past couple of years as we've had more players become public and grow larger.

Actually, I think this is a positive sign for REITs as investments because it shows that the players within the sector are willing to make the necessary moves to maximize shareholder value. Consolidation is one way to achieve necessary economies of scale to lower operating costs and potentially increase shareholder value.

Q: What specific advantage does consolidation bring to the REIT industry and its investors? In general, I think consolidation is a good thing. Growing larger always brings with it additional risk, and that should be made clear. However, growing larger also means greater liquidity and more shares trading hands, which also allows a larger number of investors to safely invest in the sector. It makes ease of entry and exit in the stocks easier.

Q: Does the potential monetary crisis in Asia, specifically Japan's problems, have an impact on REITs in the United States? It's affected some of the West Coast REITs, and there still may be more potential risks if the Asian situation continues to be negative. Any real impact, though, wouldn't be felt until three or four years out. The situation would have to significantly affect our economy first to affect real estate fundamentals. There would have to be a drop in demand for office or industrial space to really affect those markets.

Q: Are REITs inflating real estate prices in a frenzied effort to please Wall Street by acquiring more and more property? There has been a considerable amount of frenzied acquisition over the past 18 months, and while I think it was becoming a bad thing, the fact that share prices are down over 8% has tempered activity a good deal. On the same side, however, we are seeing more private players that have access to more private debt, and they are now the ones that are pushing prices upward.

Q: At what percentage over replacement cost is a bad price for REIT companies to pay? Generally speaking, par is what you want to pay, but there are a few exceptions. Purchasing above par is acceptable, for instance, if there is considerable embedded rent growth that comes with the property. In other words, a REIT could be paying essentially what is replacement cost for a property that could raise rents 30% to 40%. Of course, if there is a development opportunity that also will get you higher than average returns, paying above par is acceptable.

Q: How does Wall Street view REITs? Are they considered stocks, real estate or both? Well, I think there is still a significant debate on Wall Street, but overall it views REITs as exposure to real estate. A number of pension funds still view REITs as common stocks. The reality, however, is that they are both.

Essentially, REITs are common stock that give you ownership in real estate. The benefits of REITs are that they give you greater liquidity and easier valuation. But the flipside of that is the fact that REITs are subject to capital markets risk that include a broad market sell-off as well as the risk of significantly higher interest rates.

A certified public accountant and Harvard College alumnus, Jay Leupp began his career in real estate as a development manager with Atlanta-based Trammell Crow Residential, the nation's largest developer of multifamily housing.

Following a stint with the Staubach Co., where he specialized in the leasing, acquisition and financing of commercial real estate as one of the company's vice presidents, Leupp returned to his native California seeking a different sort of assignment.

Today he oversees a five-person real estate research team for San Francisco-based BancAmerica/Robertson Stephens (BARS), a global financial services company.

Founded in 1978, Robertson Stephens was acquired in 1997 by Bank of America, as a wholly owned subsidiary. The firm's two major business lines are investment banking and securities, research and brokerage.

Covering almost 600 public companies, BARS managed 122 equity offerings in 1997, raising more than $12.2 billion. In the past decade, the company also has completed 287 mergers, acquisitions or divestitures valued at $32 billion.

One of the few Wall Street analysts with direct real estate experience, Leupp and his staff cover the multifamily, office, industrial, self-storage, health care, hotel and other diversified real estate sectors.