By Jada A. Graves

1. What opportunities and challenges do you foresee for the REIT industry in 2007?

There are many opportunities for new companies in the REIT industry. In spite of the consolidation activity, the overall equity capitalization of the REIT market has gone up.

Mathematically, it’s a function of the appreciation of the stocks offsetting the amount of equity taken out of the market. This has two related impacts—valuations of remaining public companies are quite high, and a lot of capital will get reinvested. As a result, there are very strong opportunities for IPO candidates to exploit this demand in 2007.

A number of existing REITs have well-regarded management teams that are executing strategies to take advantage of the significant capital flow into the private equity market through ventures or discretionary commingled funds. You’ll see continued activity throughout 2007, as public companies refine their capital access strategies to ensure access in any capital or fundamental market cycle.

One of the biggest challenges will continue to be whether REIT investors value public companies as a private investor might value them. If there continues to be an arbitrage between private and public, we’ll continue to see REITs go private. You’ve seen that arbitrage decline in the last six months of 2006, as the proceeds from recent go-privates have been reinvested, thereby driving strong price performance. As a result, privatizations are now becoming tougher to justify as the valuation gap closes. However, once the reinvestment process has run its course, REIT investors must maintain modest return requirements or there will be continued privatization.

Public company costs will continue to be a structural burden that is significantly higher on smaller cap names than the larger cap names. That will continue to be a challenge for these companies and will drive additional transactions.

2. Given the amount of deal activity within the REIT industry during 2006, what does the public market landscape look like in 2007?

The public market is going to continue to be quite active. Macro-demographic trends within our general population and the desire for yield-oriented investments mean continued demand among investors for REIT securities, including REIT common stock, preferred stock and investment grade debt.

In addition, the large amount of capital that is now invested on the private side provides a strong floor for values in the public market. This, and the combination of liquidity, stable interest rates, and, for the most part, strong fundamentals across all asset classes, means that 2007 should be another solid year for REIT shares.

However, looking out to 2008, I’d say there is a greater probability of some contraction in REIT multiples, rather than steady or rising multiples as the rates of earnings growth begin to fall. As a result, total returns won’t approach the levels we saw in 2006.

From a deal perspective, I think we will continue to see M&A activity, including the return of more traditional mergers as the public to private pricing gap closes, more cross-border deals in some sectors and more IPOs as private companies and asset managers look to take advantage of the excess liquidity created by the sale of several large public REITs.

3. Which sectors are the ones to watch in 2007, and why?

I would say the hotel sector, as hotels remain cheap on a relative basis to other sectors—particularly if you believe that construction costs will remain high, therefore depressing new supply, and that the Federal Reserve Board will engineer a soft landing with the economy maintaining solid growth and continuing to create jobs.

4. What advice do you have for seasoned investors in REIT stocks as they look at the market going forward?

Some of the bigger themes within the market have been disclosure and governance. While it has gotten better, I think ambiguity within financial reports remains an issue with a number of public REITs. In addition, the lack of strong governance will stand out more in the future, given the significant improvements made by many companies. Those are two areas I would encourage investors to focus on.

Another piece of advice would be to relax leverage restraint to some degree. From my perspective, the REIT market remains somewhat underleveraged, particularly given the improvements in transparency, speed of information flow, broad capital access and the strong, tested management teams that now characterize the REIT marketplace. The improvement in equity returns would more than offset the financial risk associated with an extra five percentage points of leverage. In other words, many of these companies have more equity capitalization than they should to get optimal risk adjusted equity returns.