With the exception of gold funds, the hard-luck story of the year in the mutual-fund business has been funds of real estate investment trusts, or REITs.

Even highly publicized interest in REITs this spring by megabuck investor Warren Buffett has done little to help REIT funds recover from a disastrous 1998, when REITs fell nearly 20 percent while major stock indexes climbed nearly 30 percent.

One reason is that promoters of REITs and REIT funds can't seem to get their story straight. The confusion has created a buying opportunity for people who understand the primary role of real estate investing as an inflation hedge and income generator.

Like mutual funds, REITs are pools of investments offering diversification and professional management. But REITs, whose shares trade on stock exchanges, buy and sell real estate properties, not stocks and bonds.

Typically, REIT funds provide higher dividend yields than most stock funds, because REITs are required to distribute to their shareholders 95 percent of their profits.

Moreover, investment returns on real estate historically run counter to stock and bond returns, which should make real estate a good way to diversify an investment portfolio.

But the real estate story, whatever its merits, has been overshadowed by investors' demand for immediate and persistent capital gains, something real estate investments simply cannot deliver in a low-inflation environment.

The index of REIT securities compiled by the National Association of Real Estate Investment Trusts shows that "equity REITs," the tax-advantaged organizations that buy and sell real estate properties, produced an essentially zero return so far this year and lost about 6 percent over the past 12 months.

"The mood among REIT investors remains morose--or maybe comatose," David Sherman, REIT analyst at Salomon Smith Barney, wrote in a report last week. "The group has been on a steady slide since May 13, during which all of the gains for the year have been wiped out. . . . Investors have spoken. The broad market goes down, and REITs go down. The broad market bounces back up, and REITs go down."

The scarcity of real estate in desirable locations continues to create a compelling investment opportunity. And continual changes in the way people around the world live, work and shop create opportunities for skillful real estate managers to generate steady income from raw land. But that's where the story ends.

"The bottom line is real estate represents a certain portion of investable wealth out there, and a properly diversified investor should be invested in it," said Kerry Vandell, director of the Center for Urban Land Economics Research at the University of Wisconsin at Madison. This fall, Vandell will oversee a new student investment program focused on real estate securities similar to the school's investment programs for stocks and fixed-income securities.

REIT securities have a checkered background arising from the 1980s, when the industry expanded through politically motivated tax breaks and profligate lending. To survive the collapse of that era, real estate operators invented REIT securities as a way of enticing ordinary investors to take the place of suddenly recalcitrant bankers.

"They needed to recapitalize, they were overleveraged, they had to pay back those loans," Kenneth Rosen, chairman of the Fisher Center for Real Estate at the University of California at Berkeley, told a recent seminar. "And the difference between an S-11 filing, which is used to do a public offering, and a Chapter 11 [bankruptcy] filing was about 10 pages."

With that unsavory pedigree, REITs have attempted to promote themselves as distinctive securities offering the best of both worlds: equity growth and high dividends. REIT managers have tried to portray themselves as entrepreneurs creating wealth rather than what they are, superintendents of wealth and distributors of income.

"There was some notion that somehow these were growth stocks, and that clearly was not the case," Vandell said. "There was no way that growth was sustainable. In the long run, real estate is not appreciating."

The most desirable feature that REITs share with corporate stocks is liquidity. Despite the complexity of REITs, the securities are readily available and easily tradable--attributes not usually associated with real estate investing.

Richard Imperiale, president of Milwaukee-based money-management firm Uniplan and manager of a new REIT fund offered by San Francisco-based Forward Funds, said investors in real estate funds should look for funds that offer the purest form of real estate ownership through the REIT structure.

Many real estate funds invest in shares of home builders, mobile-home manufacturers and other ancillary businesses. You might as well own a small-cap stock fund.

"There are very few pure-play REIT funds," Imperiale said. The fund should demonstrate low turnover because of the multiyear cycle in real estate opportunities, he added.

Also, look for funds that favor REITs with financial ties to private real estate investors and where REIT managers are buying back their shares in the slump, Imperiale said.