Faced with scenes of carnage on the battlefield previously known as the listed property sector, investors are fleeing real estate investment trusts exposed to debt and taking cover in cash and quality REITs until the smoke clears.

After a 10-year bull run and five years of 20 per cent-plus annual returns, the S&P/ASX 200 Listed Property Accumulation Index fell 36 per cent in the year to June, compared with a fall of 17 per cent in the broader sharemarket.

Global property is not faring much better, with a 32 per cent fall last financial year.

At a Morningstar conference last month, Carlos Cocaro of the boutique property fund manager Renaissance Asset Management attributed the decline in listed property to growing levels of volatility, unrealistic property prices and too much risk built into their strategies for the rewards on offer.

Over the past 10 years, pressure from investors for higher yields has seen many property groups shifting their focus away from traditional rental income to property development and funds management. While this strategy boosted income, it also resulted in higher levels of debt.

When global credit dried up last year, highly leveraged REITs were unable to refinance short-term debt and their high-risk strategies unravelled.

As is often the case when an entire market sector is dumped, the flight from listed property was triggered by one company's fall from grace. Even professional fund managers were caught off guard by the revelation that Centro Properties Group was unable to refinance its debt and the retribution has been merciless.

Centro shares fell 97 per cent in the year to June and REITs with high debt and exposure to development and funds management have also been targeted. A wave of earnings downgrades and distribution cuts over the past month has exacerbated the sell-off.

Australia's second-largest property trust, GPT Group, recently downgraded its earnings for the year to December by almost a third and cut its final distribution. Property market analysts are anxiously reviewing the sector, with some convinced Centro is on the brink of bankruptcy.

Ratings agency Moody's has announced it is reviewing GPT and Macquarie Prime REIT for possible ratings downgrades. This follows GPT's earnings downgrade and uncertainty about Macquarie Prime's asset profile, ownership structure and debt refinancing issues.

At the other end of the scale, larger, high-quality companies with a traditional emphasis on rental income have been treated more kindly. Westfield Group, the largest company in the index at just over 40 per cent, fell just 13 per cent in the 12 months to June.

Renaissance director Damien Barrack believes the current bloodbath will ultimately be positive for the sector. "The cleansing of the decks has begun. What's left will be a cleaner, healthier sector," he says.

Barrack also points out that listed property mostly responds more quickly to market conditions than the physical property market and tends to overreact.

In a recent review of the property securities fund sector, research house Lonsec concluded: "Investors should remain cautious and focus on the plain vanilla property trusts that have a bias to Australian property, high occupancy, mostly rental income, reasonable levels of gearing and manageable lease and debt maturity profiles."

Barrack agrees. He says the groups performing well now are low-geared, with quality assets such as Westfield and Colonial First State Retail Property Trust. Both have quality shopping centres with a ratio of debt to assets below 40 per cent.

The only bright spot for investors is that plunging share prices have made the yields on REITs even more attractive than usual. The sector is yielding more than 9 per cent, compared with 7-9 per cent for cash investments and the 6.4 per cent yield on a 10-year government bond.

Colonial First State's head of investment market research, Hans Kunnen, says this difference in yield, combined with continuing growth in the economy, may provide some support for the sector over the remainder of 2008.

However, there is also general agreement that current yields are unsustainable.

Barrack points out that at the listed property sector's peak, yields got down to 5.5 per cent (the higher the unit price, the lower the yield), compared with their traditional yields of 7-8 per cent. He says the current wave of earnings downgrades and cuts to payout ratios will mean a return to healthier yields.

In its annual sector review, Lonsec awarded only two of the 18 funds it covers with its highest rating.

The UBS Property Securities Fund was highly recommended despite the pounding it took for its exposure to Centro. Lonsec analyst Paul Pavlidis said the UBS fund was rated highly for its strong management team, bottom-up approach to stock selection and active management style, which allows it to stray further from the index weighting than most.

This last point is important when one stock - Westfield - dominates the sector because there will be times when there are better opportunities elsewhere. Last February, the 18 funds reviewed by Lonsec held an average of 28.2 per cent of their portfolio in Westfield.

Partly for this reason, Lonsec upgraded Vanguard's Property Securities Index Fund to highly recommended. Pavlidis says it makes little sense to pay the higher fees charged by non-index funds when most of them passively hold all stocks in the sector at or near their index weighting. He believes the Vanguard fund performs a similar function for a lower fee and is very efficiently run.

Most market analysts believe there is more bad news to come from the sector and are anxiously awaiting the profit reporting season, which gets under way next month.

For this reason, Barrack believes it's too early to say if the sector has hit rock-bottom. "Over the next 6-12 months, we expect more volatility," he says.

Longer term, Barrack sees opportunities developing in oversold stocks. There are some vehicles in the sector where very high yields are a serious issue but there are others where sustainability as a vehicle is not in doubt but they have been overly penalised.

"Analysis of previous downturns shows that the bounce back is often high. For example, if a stock falls 30 per cent it can bounce back 20 per cent," he says.

Over the long term, Lonsec expects REITs will deliver total returns of 8-10 per cent a year. Perhaps then the sector can reclaim its reputation as a source of stable income streams.