REIT funds are back in fashion. Should your portfolio dress up in real estate instruments, too?

Last year, you couldn't find a worse investment sector than real estate investment trusts (REITs). In 2007, when the S&P 500 benchmark grew a modest 3.2 percent, the average mutual fund with a REIT focus lost more than 14 percent. As of May12, 2008, those funds were boasting a market-beating 5.6 percent five-month return. The black sheep of the market has turned a downy white once again.

The REIT turnaround

After a very disappointing year, many REIT funds started 2008 looking very cheap. Nobody can call the absolute bottom of the downswing in real estate prices and market demand, but value-oriented investors start to salivate when they see any particular sector as depressed as the recent real estate market. When money starts flowing into these mutual funds again rather than out, the prices of the underlying REIT stocks will edge up. Mutual funds and other large financial institutions play a large part in the stock market's price movements.

Looking to the future

If you believe that the broader real estate market has yet to fall to its lowest point, this REIT rally might look premature. Just remember that investors are buying a stake in the future of a company or, in the case of mutual funds, in a basket of companies. Many individual investors just like you, as well as professionals with massive investment budgets, have been placing their bets on a brighter future coming up fairly soon.

Then again, maybe you think that we've already bounced off rock-bottom levels in housing and commercial construction. Is it too late to jump aboard the bandwagon and buy into a market in the early throes of another boom cycle?

Not necessarily. If you missed the first few months of a fresh upswing that should have legs for at least a couple of years, you may have missed the absolute peak returns in that market. But nobody hands out medals for hitting every peak at its apex. You'd make a far greater mistake by staying out of a hot market just because you missed the perfect entry point.

Right time for REITS?

A REIT fund can be a great addition to many investment portfolios, thanks to unusually large dividend yields and the aforementioned positive aspects of the real estate market at this moment in time. But you may not see any great promise in REIT investments at the moment, while other sectors like retail or semiconductors might make more sense to you. A REIT is a complex construction of tax benefits that come with strict requirements, so it can be difficult to see how such rules would help or hurt your investments when the housing market moves in different directions.

The bottom line is simple: buy REIT funds if you understand and believe in that market and don't worry too much about perfect timing. You may be wrong, but you also may be REIT.