By Bernard Winograd

The past few years have seen conditions in the real estate capital markets that are almost the polar opposite of those that prevailed during the early 1990s, when REIT market capitalization first took off. At that time, debt was scarce and expensive, the private markets were illiquid, buyers were scarce and bid/ask spreads were wide. Back then, REITs were the only sources of capital and enjoyed a healthy acquisition market. Also at that time, U.S. REITs were a new phenomenon with no appreciable investor competition from overseas REIT markets.

Recently, debt has been freely available and quite cheap. In fact, almost every property has found a buyer, with the most desirable properties attracting intense bidding. REITs are not raising new equity and many are going private, including strong, well-run businesses, because private sources of capital are the winning bidders in property auctions. Also, REIT investors are increasingly interested in countries with emerging REIT markets.

Is this a sign of old age or just maturity for the U.S. REIT market? To paraphrase James Carville, the answer to that question is, "it's the debt market, stupid." In real estate, what's going on in the debt markets almost always drives what's going on in the equity markets.

This recent period is no different. Debt has been cheaper than equity, so when it's freely available and cheaply priced, companies financed by debt will outbid less-leveraged players. This is especially true in an asset class that is easy to leverage, such as real estate. Today, debt-driven acquisition models determine the price of properties being sold.

Debt markets began to show signs of backing up in 2007. But markets always overshoot, and the real estate party has gone on for a long time and accumulated many players who have unsatisfied appetites for debt in their portfolios. It will take a while for a debt market backup to make a big dent in equity values. At least initially, a repricing of debt is more likely to slow the rate of appreciation, as has occurred in 2007, than to precipitate falling equity values.

Some have complained that REITs are undervalued because they seem unable to trade above NAV on a sustained basis. However, REIT yields are at historic lows, and it is extremely unlikely that U.S. REITs will perform as well in the future as they have over the past 10 years, which limits their price.

This is the reason that REIT investors look overseas at the moment, hoping that new markets will give them opportunity to repeat the profitable ride they enjoyed from the past 15 years' mainstreaming and repricing of REITs in the U.S. NAVs are high at the moment because the purchasing power enjoyed by debt-financed buyers has pushed asset values to extremely high levels. Consequently, a low-leverage REIT should have a hard time trading above NAV in this market.

As Herb Stein famously said, trends that are unsustainable tend to stop. The cycle will turn at some point. Debt will not be freely available and cheaply priced forever. U.S. REITs will again be the center of attention when the market conditions are right.

Until then, enjoy the ride.