Dan Fasulo crunches data for commercial real estate investors all day. Still, the managing director of researcher Real Capital Analytics doesn't understand what's happening with one stock in his personal portfolio, AvalonBay Communities (NYSE:AVB - News). The real estate investment trust (REIT) has an interest in more than 51,000 apartments in coastal cities such as Boston, New York, and San Francisco, where rents are high and new construction is hard to pull off. Yet the stock is down 27% this year. "These are premium assets," says Fasulo. "Someone should tell Wall Street."

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A lot of people thought a cooling housing market would be good for apartment owners. A drop in home-ownership would seem likely to turn the tide back toward renting. But you wouldn't know it from looking at the publicly traded companies in the apartment sector. The average apartment REIT is down 27% this year, according to the National Association of Real Estate Investment Trusts.

Why? As lenders tighten their standards, appetite for all kinds of property is lessening. With apartments, there's another bogeyman -- recession fears. Apartment REITs were among the worst performers during the last recession. As the job market slows again, people are less likely to move or trade up to bigger apartments, and vacancy rates are expected to rise modestly.

Location, Location

With many apartment REITs already beaten up, however, pros see some values. The REITs pay an average dividend of 5%, and fundamentals still look good, says David Baird, who tracks multifamily housing for research firm Sperry Van Ness. He predicts rents will rise 3.5% in 2008. That's below the 5% annual hikes landlords enjoyed over the past two years but still strong. Moreover, new construction isn't likely to rise from the current pace of roughly 200,000 units a year.

As always in real estate, location is key. Michael Kirby of investment firm Green Street Advisors suggests avoiding apartment REITs in markets such as Phoenix and San Diego where there's a "shadow supply" of homes and condos being rented out because buyers are scarce. His firm likes Fasulo's stock -- AvalonBay in Alexandria, Va. -- thanks to its stakes in markets where demand is strong and supply is tight. He expects AvalonBay's sales and profits to beat industry averages by rising more than 4% annually over the next two years.

On top of location, UBS (NYSE:UBS - News) analyst Alexander Goldfarb seeks management that creates value. For example, Essex Property Trust (NYSE:ESS - News) in Palo Alto, Calif., fixes up older complexes in coastal California and Seattle. Then there's Home Properties in Rochester, N.Y., with assets concentrated in the Northeast, where scarce supply and strong job growth should keep rents climbing. Home recently began requiring tenants to pay their utilities, which helps insulate it from rising energy prices. Through the first nine months of 2007, profits were up 6.7% and rents 4.4%. But shares are down 26% this year. "If you're bracing for a slowdown, it's a business that should continue to perform well," Goldfarb says.

Similarly, he says Denver's Apartment & Investment Management (NYSE:AIV - News), a national operator that owns more than 206,000 apartments, is a good bet. It also focuses on redeveloping older buildings, and its stock, down 34% this year, is "the kind of play deep-value investors look for."

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