A two-week rally has sent the Morgan Stanley REIT Index up 6 percent, bringing the increase so far this year to 11.7 percent -- compared with a 2.5 percent decline for the Dow Jones Index in the same time. Sounds good, especially since the REIT index was in the dumps earlier this year. But the perception does not fit the reality, some analysts say.

Indeed, storm clouds are gathering. The latest warning sign comes from Smith Barney analyst Jonathan Litt, who in a recent report illustrated how REIT dividend yields -- what many point to as the prime factor driving the rally, are no longer at a premium compared with other options.

Litt says in the report that, with REIT dividend yields at 4.5 percent overall and 3.2 percent adjusted for taxes, 88 companies within the S&P 400, 500 and 600 offer comparable returns. In 2003, just 27 had comparable returns. Moreover, a full one-third of REIT yields were below the 10-year Treasury. In 2003 REITs on the whole enjoyed a 40 basis point spread.

"We can no longer explain the REIT rally as a function of investors thirst for yield," Litt says. The REIT analyst has a "flat to down 10 percent" view for REITs in 2005, although he added, "there is nothing imminent to derail the rally."

Litt's not alone. According to a recent Morgan Stanley report compiled by retail REIT analyst Matthew Ostrower, mall and shopping center REIT cap rates are at their lowest absolute levels since 1996.

"Likewise, implied price per square foot is higher today than at almost any point in the valuation history we have compiled," according to the Morgan Stanley report. Retail REITs are trading at a 10 percent premium to underlying net asset value -- according to Morgan Stanley. In contrast, in 2003, retail REITs were trading at a 5 percent discount to NAV.

REITs have taken advantage of their popularity to hit the market up repeatedly with new IPOs and secondary offerings. Through the first six months of 2005, 107 total offerings raised $17.6 billion. That's just slightly off 2004's pace of 266 offerings raising $38.7 billion. In the past two years, there have been 35 REIT IPOs compared with just 13 in the previous five years combined. (That is eerily reminiscent of the Internet mania: In 1999, 292 IPOs raised $24.1 billion. In 1998, 45 IPOs raised $2.1 billion.)

In all, 195 REITs have a combined market cap of $326.4 billion. That's more than double the size of the REIT universe in 2002 when 189 public REITs had a combined market cap of $138.7 billion.

--David Bodamer