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Despite a one-week dip of 4.3% through April 11, iShares Cohen & Steers Realty Majors ETF (NYSEARCA:ICF) has held up well in 2008, with a three-month jump of 12.6% and a year-to-date gain of 4.4%, better than the S&P 500 by 17 and 13 percentage points, respectively.

Given the real estate downturn, that may seem surprising—especially because the fund enjoyed a nonstop run-up until early 2007—but some REITs can benefit from sluggish home sales, the sector as a whole has a low correlation with stocks, and some investors see a bargain after REITs took a beating in 2007 and early 2008.

ICF’s portfolio shuns risky (and recently deadly) mortgage REITs, focusing on the stocks of diversified firms and retail, industrial, office, and multifamily sectors. That’s offered the ETF some protection from direct damage from the retail real estate crash, at least for now. These stocks may not, however, survive the continuing fallout of the crash and its impact on the broader economy.

ICF focuses on firms that hold retail and office properties. The fund’s top four holdings—mall-operating giant Simon Property Group (NYSE:SPG); No. 2 ProLogis (NYSE:PLD), which specializes in warehouse and distribution centers; No. 3 Vornado (NYSE:VNO) (office and retail); and No. 4 Boston Properties (NYSE:BXP) (office buildings)—saw their share prices gain an average of 9.1% in the month ended April 11.

No. 5 holding Public Storage (NYSE:PSA), which owns and operates self-storage facilities, is one company whose stock has benefited from the real estate slowdown, with shares up 21.8% year to date. Revenues are up, which is often credited to foreclosure victims needing to store their stuff.

Within the residential sector, ICF’s biggest bets are on No. 6 Equity Residential (NYSE:EQR) (shares up 10.26% YTD) and No. 10 AvalonBay (NYSE:AVB) (up 3.35% year to date). The stocks of these two major players in apartment leasing have benefited from real estate’s troubles.

ICF, which languished at 41st out of 44 funds on our ETF Momentum Tracker Sector Momentum Table in January, has moved 17 spots over the last four weeks, from 34th to 17th on April 8.

Last year marked the end of a magnificent run for ICF, which offered above-average market yield and an annualized gain of 19% from its 2001 inception through the first half of 2007. The ETF peaked in February of 2007, then lost nearly half its value over the next 11 months, bottoming out on Jan. 27.

In an early April speech, Marty Cohen, co-chairman and co-chief executive of New York’s Cohen & Steers, said the fall was the “worst bear market” in REIT history. (ICF tracks its namesake index, which invests in REITs that meet the liquidity and quality standards of Cohen’s firm’s investment committee, according to Morningstar.)

The fall, Cohen said, creates opportunity in the space, because REITs are now trading at a discount to their underlying assets—a condition that historically has led to the sector outperforming the broader market. Cohen sees a quick recovery for REITs and emphasized that he views the sector’s troubles as perception, not fundamentals. At their peak in 2007, REITs sold for more than their net asset value. Recently, they traded at a 17% discount.

From Jan. 22 to April 3, the day of Cohen’s speech, ICF gained 23.5%. It remains up 16% since that day (through April 11).

Long known as high-yield income investments—before they became growth stocks in the last seven years—REITs once again offer solid yields, with ICF recently yielding 4.7%.That said, the sector and the fund carry a great deal of risk in these volatile times. S&P holds a neutral outlook on the six categories it uses to break down REITs: diversified, industrial, office, residential, retail, and specialized.

If the economy worsens further, office tenants could pull back on space needs and retailers could continue to close outlets, hurting mall and shopping center REITs. And more empty houses could cut into rent increases recently enjoyed by residential REITs.

Finally, REIT dividends are taxed as ordinary income and thus not subject to the 15% rate applied to most stock dividends. That can hurt after-tax returns in taxable investment accounts, especially for investors in high tax brackets.

The bigger potential downfall for ICF lies with the state of the economy and the sector’s long rally. Bargain hunters should remember that the fund’s NAV remains nearly twice as high as five years ago and note the roller-coaster swings of the financial sector. There could be more pain in the sector, and it could be dramatic. A small stake in ICF can help boost returns and diversify your portfolio, but it’s best to keep that stake small.

Source: ICF: The Surprising Rise of REITs in a Real Estate Downturn