By J. Allen Smith

After the spate of mergers and privatizations over the past few years and a dearth of initial public offerings, it may seem impossible to reconcile these trends in the U.S. REIT market with those elsewhere in the world. Remarkably, since year-end 2004, the number of equity REITs in the FTSE NAREIT All REIT Index has fallen from more than 150 to fewer than 120, making the current field of public REITs the smallest since 1993. Although the capitalization of the U.S. REIT market has increased by 10 percent to 15 percent during this time, most of the growth can be explained by share price appreciation, rather than growth in the REIT market's asset base.

However, the REIT industry outside the United States has been expanding at a healthy pace since the start of this decade. In an effort to promote the growth and development of vibrant public real estate markets, countries throughout Asia, Europe, Africa and the Middle East have introduced or amended legislation governing the structure of tax-transparent, listed property companies. Although REIT regimes in a few countries, such as South Korea and Taiwan, have yet to find traction with investors or property owners, others have gained acceptance and emerged as important sources of capital for the industry and opportunities for investors.

On the surface, the divergent trends seem irreconcilable. Within the United States, the thinning ranks of REITs have resurrected the debate over the optimal format for owning and investing in commercial real estate. However, when viewed from an industry perspective over the longer term, it seems clear that the ability for capital and assets to flow back and forth between the public and private markets is a sign of the maturity of the asset class and the improved efficiency of the capital markets.

Over the past several years, REITs clearly have been at a competitive disadvantage to private real estate funds and investors who could take advantage of the incredibly inexpensive and abundant debt that helped drive asset prices higher. But it was not that long ago that the tables were turned. REITs were gobbling up assets at steep discounts using capital from the public equity markets. Just as predictions then that REITs would eventually marginalize private vehicles were at best premature, so, too, are reports today of the impending demise of the listed U.S. REIT market.

It remains to be seen just how the U.S. REIT landscape will change once the credit market turmoil subsides and capital begins to flow again. If we have learned nothing else from the experience of the past few years, it is that the cost of capital and investor sentiment matter. We can be sure that, as the financial markets continue to deleverage, investors who have relied on ample, cheap debt and financial engineering to achieve target returns will have a much harder time competing for assets in the transaction market. Therefore, low-leverage investors, including REITs, should offer attractive opportunities for capital seeking exposure to income-producing real estate.

Against a backdrop of limited supply, high replacement costs, rising inflation and increasing global demand for yield, commercial real estate should compare very favorably with the other major asset classes. The expanding REIT industry will only enhance the appeal of the asset class, providing unprecedented access to a rich and diverse set of opportunities and the means to build and manage liquid, global portfolios.