By Ralph Block

Forecasting is especially difficult in the investment world. In the REIT industry, the crystal ball must first accurately anticipate the direction and magnitude of changes in the vast and varied markets. Second, and even more challenging, it must assess how these shifting conditions, both real-time and prospective, along with interest rate and other changes, will affect asset pricing. Thanks to short investor time horizons and the increased velocity of worldwide capital flows, this task is more daunting than ever.

Nevertheless, let's hazard some predictions for 2007. The U.S. economy is emitting mixed signals. We should expect slower consumer spending due to only modest wage gains, stubbornly high energy costs and continued softness in the home markets. However, job growth will remain respectable and corporations have ample liquidity to fund increasing capital expenditures. Inflation will abate, and headwinds from a more cautious consumer will be softened by flattening interest rates.

Capital markets are often more volatile. Yet, with only a few exceptions, we didn't experience increasing cap rates in 2006 despite rising short-term interest rates, which are likely to remain stable this year. Any changes in cap rates or REIT stock price multiples would probably come from real or anticipated changes in real estate market fundamentals and perceived risks from changes in risk-adjusted return expectations of other asset classes.

Such changes depend upon the U.S. and global economies. Economists' forecasts have generally been as accurate as next year's weather predictions. Nevertheless, U.S. GDP growth of 2 percent to 3 percent, along with modest inflation, is a likely scenario. Under these favorable conditions, it would be difficult to argue that commercial real estate values or REIT stocks price multiples should be marked up or down significantly.

As for competition from other asset classes, bond yields seem appropriate, given perceived credit risk and inflation expectations. The large universe of equities is a tougher call. Although valuations look modestly attractive, profit margins and growth rates may be peaking.Perhaps returns on equities will chug along at 7 percent to 8 percent. Accordingly, there is little reason to expect that capital will leave commercial real estate for either bonds or stocks.

Taken together, these factors suggest that REIT shareholders will enjoy another solid year. Expectations of 8 percent to 10 percent total returns, based upon 4 percent dividend yields and 4 percent to 6 percent in capital appreciation from continuing FFO and NAV growth, seem reasonable.

Even though international real estate markets and opportunity funds are siphoning off chunks of capital, underweighted investors will continue to pursue U.S. commercial real estate. This will lead to more joint ventures between REIT organizations and anxious pension funds, a win-win situation. Meanwhile, the influence of private equity capital will remain strong, particularly if REIT stocks experience a temporary downdraft. However, much of the low-hanging fruit has already been picked, so the volume of REIT privatizations will be moderate.

As U.S. commercial real estate markets remain very competitive, a few REITs will step up their investments overseas, focusing on markets that are less efficiently priced or where their vast expertise can be levered. Most of this will be done in JV format with local players. However, domestic opportunities will also be exploited. Many REITs will expand development pipelines, particularly as occupancy rates continue to rise modestly and as construction costs moderate due to lower commodity prices, labor market loosening and disappearing condo converters.

So I see no dramatic changes or exciting times on the horizon for REIT investors for 2007. However, except for high-tech stock plungers, excitement in the investment world has always been overrated.