In 2000 and 2001, as stock prices withered and interest rates dropped to historic lows, retirees seeking investment income were able to find safety and attractive dividends in the shares of real estate investment trusts (REITs), stocks that represent shares in companies that own and operate productive real estate.

But by this summer, that safe haven no longer seemed quite so safe. Hopes for a swift economic recovery had dimmed. The commercial real estate market was weakening, and REIT stock prices were in retreat. Not surprisingly, investors began to ask whether REITs would be forced to cut the dividends that provided such nice income for retirees.

The answer to that question, Wall Street analysts tell me, will depend heavily on whether the economy picks up in 2003. A double-dip recession could be bad news for REITs, for their dividends -- and for the retirees who depend on both. Retirees and other income-oriented investors have already lost the traditional safe haven of utility stocks -- at least four utilities have cut their dividends.

REITs have long been popular with the older set for a very good reason: The dividends compare very favorably with the returns available on other investments. REITs, on the average, were paying a 7.32 percent dividend, as of Sept. 30. By comparison, one-year bank certificates of deposit were paying 2.35 percent, mutual fund money-market accounts were paying 1.81 percent and the 10-year Treasury bond was yielding 3.59 percent.

The reason REITs pay such healthy dividends has a lot to do with the rules that govern real estate investment trusts. A REIT is a company that owns and usually operates income-producing properties. Many such companies specialize in a certain type of property, such as office buildings, apartment buildings, shopping centers, hotels or warehouses. To qualify as a REIT, a company must distribute at least 90 percent of its taxable income to its shareholders every year. Because the REIT is allowed to deduct these dividends from its corporate tax bill, most REITs pay little if any federal taxes.

Although the prices of REIT stocks have fluctuated widely during the past five years as the result of market and economic factors, dividends have remained relatively stable, averaging 7.8 percent from 1998 through the first nine months of 2002. But in the past two years, the recession and a sluggish recovery have led to a slowdown in the growth of REIT earnings. That growth has all but vanished this year, worrying investors.

I discussed the possibility of dividend cuts with Wall Street analysts and with several industry experts. At this point, they said, they expect a relatively small number of dividend cuts but not widespread reductions. But they generally agreed that if the United States goes into a double-dip recession, many more REITs may have to cut their dividends.

"The likelihood of some dividend cuts is very high. The likelihood of most companies cutting dividends is very low," said David Shulman, managing director and senior REIT analyst at Lehman Brothers. Shulman, who described himself as "bearish" on REITs, said that if the economy can avoid a double-dip recession, REITs will find themselves in a "muddle-through" scenario in 2003.

"In that kind of environment, we'll have a dividend cut here or a dividend cut there," he said. "But investors will be worried about it through most of the year," he added. Once REITs get past 2003, Shulman predicted, "2004 will be a pretty good year."

Any dividend cuts, analysts said, probably would take place among the REITs that have been most affected by the economic slowdown. These include the ones that invest in apartment and office buildings. Vacancy rates have been rising in both sectors for some time.

For instance, apartments had a 3 percent vacancy rate in 2000. That rose to 4.8 percent in 2001, and it is estimated to be 6.3 percent in 2002. Offices had a 7.9 percent vacancy rate in 2000, which rose to 13.7 percent in 2001 and is estimated to be 15.8 percent this year, according to Reis Inc., a New York research firm.

Varying factors were at work in creating these higher vacancy rates. REITs that invest in office buildings were hit by the collapse of dot-com, computer and telecom companies and the general slowdown in business. REITs that invest in apartments were affected by the drop in interest rates. With home mortgages available at about 6 percent, industry observers said, many renters bought their own homes. Secondly, growing unemployment caused many young people to move in with their families. Meanwhile, REITs that invest in retail properties seem to have been somewhat less affected by the economic slowdown, industry observers reported. Similarly, REITs that invest in industrial sites -- warehouses, factories, etc. -- have been holding up well so far. Both sectors, however, have seen an increase in vacancies.

Because REITs own property, their income depends on the rents they can get for them. Longer-term leases tend to give REITs greater certainty about their future earnings than shorter leases. Apartment leases generally last for only one year. So an increase in vacancies is felt quickly. Office leases average about five years, so they roll over more slowly. Retail and industrial leases generally are for multiyear periods.

Michael Grupe, senior vice president of research and investment affairs at the National Association of Real Estate Investment Trusts, a trade association based in Washington, offered this appraisal of the problems facing REITs:

"My general sense is that widespread dividend cuts are unlikely. I think we should expect to see somewhat weaker earnings growth because of a weak economy. But I do not expect to see that weakness in earnings growth result in significant or widespread cuts to dividends."

In 1999, Grupe noted, earnings growth among REITs averaged about 10 percent. In 2000 that dropped to 8 percent, and in 2001 it fell to about 5 percent. In recent quarters, he said, the earnings growth had dropped to 1 or 2 percent, and some forecasts for next year are even lower.

Nevertheless, he said, REITs are still making money. "Just because the economy weakens," he noted, "it doesn't necessarily mean that all of that weakness immediately translates into the earnings of that company. It translates into the earnings as those rental contracts roll over."

Steve Sakwa, first vice president and head of REIT research at Merrill Lynch & Co., follows about 60 companies. "I would think generally, for most of the companies we cover, we believe the dividends are safe," Sakwa said. But "if business conditions continue to deteriorate . . . maybe a year from now, we'll have a different answer for you."

While the prices of REIT stocks have declined in recent months, the REITs fared much better this year than the major market indicators. The S&P 500-stock index fell 28.1 percent during the first nine months of this year. The Nasdaq composite index lost 39.9 percent. The NAREIT composite index, made up of 177 stocks, fell 8.82 percent in the third quarter but rose 4.28 percent in the first nine months.

Also, during the third quarter, the 156 mutual funds that invest in REITs fell 8.98 percent. But the funds gained 3.03 percent for the first nine months of this year, according to Lipper Analytical.

There is reason to be optimistic about the outlook for REITs, says Richard Imperiale, author of "Real Estate Investment Trusts: New Strategies for Portfolio Management."

Imperiale is the manager of the Forward Uniplan Real Estate Securities Fund, a $22 million fund based in Milwaukee that invests in 40 REITs and real estate companies.

"This real estate cycle ended differently than previous cycles," Imperiale said. "Most cycles end with a big supply of properties -- call it overbuilding -- that floods the market and causes values to go down. In this cycle, the markets were very stable, there wasn't a lot of excess supply and the demand just faded away. I would say that if the economy were to uptick just modestly, that would translate into a fairly quick tightening of the real estate market." That, in turn, would help REITs increase their income, he noted.

As for possible dividend cuts, Imperiale said, he thought most dividends are "fairly safe" until the end of the year. "The fortunes of the REITs will rise or fall on what the economic outlook for 2003 appears to be."

REIT analysts and investors rely on various numbers for clues to the safety of REIT dividends. They look at a REIT's dividend yield and at its total return -- the dividend plus the gain or loss in the stock price. They also look at the payout ratio -- the percentage of a company's earnings that it pays out in dividends.

In most cases, industry observers say, dividend payout ratios in the 60 to 70 percent range are considered reasonable. The current national average is 68 percent. Ratios above 90 percent are seen as more risky. "The higher it goes, the more likely it is to be cut," said Sakwa of Merrill Lynch. He also said it is a mistake for investors to buy REIT stocks simply because they pay the highest yields.

"While they produce high current income," Sakwa said, "there's no free lunch. People should be cognizant that there is a high yield on some of these stocks for a reason." And if a company is forced to cut its dividend, Sakwa suggested, its stock is likely to fall and investors could lose a chunk of their principal.

Investors interested in investing in REITs can find additional information in various publications and at several Web sites. A number of studies, including one by Ibbotson Associates Inc., a Chicago research firm, shows that when REITs are added to a typical stock and bond portfolio, they increase the portfolio's return and lower its risk. For individual investors, analysts suggest 5 to 10 percent of their savings in REITs.

David M. Lee, manager of the T. Rowe Price Real Estate Fund, called REITs "a very good diversifying agent" because they perform differently from both corporate stocks and bonds.

So, is this a good time or bad time to invest in REITs?

In my view, it is always a good time to diversify your portfolio and obtain a flow of long-term income, providing you can stay invested for at least five years. With REIT stocks down from their midyear highs, the shares are cheaper now than they were. But be warned. If 2003 is a bad year for the economy and for REIT dividends, the stocks could go a lot lower before they go higher.

So, if you invest in REITs, try to relax about what happens to your stocks in the short term. As Gus Sauter, managing director of the Vanguard REIT Index Fund, told me: "Things are never as good as they look during a bull market. They're never as bad as they look during a bear market."

Stan Hinden can be reached at