Leading appraisers I´ve talked to expect core institutional portfolios to register value gains averaging somewhere between 5% and 8% for the calendar year. Add in income returns, and these real estate funds should see "double digit" low to mid teens performance during 2010. Real estate is back...

Before we get too excited, appraisers are basing valuations on the handful of deals mostly occurring in prime 24-hour markets involving well-leased properties. Plenty of money has been eying premier buildings in better markets, but steering clear of secondary and tertiary real estate in lesser locations. These deals have been occurring without much regard to market supply/demand fundamentals which generally remain weak. Investors probably rightly figure it´s time to make deals in the best markets at or near cyclical lows.

But that takes us back to market fundamentals. Is there any chance for a sharp rebound that will encourage more appreciation, especially in second-tier markets? Optimism remains in much shorter supply on that question. "The 5-8% gains may be it for a while, next year may be more flat," says a top valuation pro.

Clearly capital has been making or breaking commercial real estate assets-binging and escalating pricing on the upside and more recently evaporating and crashing markets. While sidelined equity seems to be edging back into the game, anemic supply-demand may not be the only hurdle to overcome.  Of course, refinancing problems and expected ramp-ups in foreclosures loom as significant obstacles, and now private equity dealmakers raise red flags about potential Congressional action to raise taxes on carried interest from the 15% capital gains rate to ordinary income tax rates of 35% in a phased in process.

The Real Estate Roundtable as well the large private equity buyout firms contend such tax hikes would stop any recovery in its tracks, discouraging investment just when property markets show first signs of renewed life and need greater liquidity. Proponents of a tax overhaul, mostly Congressional Democrats, view carried interest as Exhibit A in tax loopholes which favor a thin sliver of ultra wealthy deal hounds at the expense of average Americans. They want to eliminate the existing generous tax treatments, which allow private equity firms to shelter gains from promotes on other people's money.

And we wonder why so many new real estate opportunity funds have been created to take advantage of the market downturn-600 plus trying to raise $125 billion or more? These guys don´t want to see any changes to current tax laws--that´s for sure.

But you could argue that the carried interest loophole combined with low interest rates helped spawn the tidal wave of equity capital into real estate markets, precipitating the unfortunate 2003-2007 price spiral.  Cheap leverage and the opportunity to reap huge gains off investors´ capital thanks to favorable fees and light tax treatment was a powerful elixir to encourage private equity firms to overheat real estate markets in a transaction orgy. 

Do you buy the spin that savvy investors will back off real estate investing at or near market bottom, because their gains will be taxed at a higher rate, especially since real estate won´t be disadvantaged-the tax changes would apply to private equity investing across all asset categories?

And maybe just maybe, the carried interest change would take the edge off of opportunity structures and help orient real estate players back towards longer-term core strategies where the emphasis is on generating income, not gaming and trading.

Without the carried interest loophole, private equity GPs can still make plenty of money riding back from market lows for themselves and their investors. But only if they focus on market supply and demand fundamentals and less on their future tax returns.  Nobody will go to the poor house if the tax law get´s changed.