"All good things must end, including the terrific run that real estate has had over the past several years," says Youguo Liang, PREI's managing director of research. "Real estate should continue to perform well this year, however, and it remains attractive to investors, particularly with the improving property fundamentals and new supply still years away in most markets."

PREI expects private, unleveraged investments, as measured by the NCREIF Property Index, to fall to between 12% and 15%, down from the 20% returns in 2005. It's also anticipated that total returns could decline further into 2007, according to Liang.

The most immediate risk over the next year or two, says Liang, is potential fallout from a slowing housing market, particularly the condo market. "A slowdown in the housing market will reverberate through the economy, including commercial real estate."

One possible casualty could be retail, where besides its symbiotic relationship to housing, a general cooling could be in the works. Indeed, according the Liang, returns on retail properties dipped below office properties in the second half of 2005 for the first time since 2001.

As far as other property sectors, office is predicted by PREI to continue to outperform retail as office fundamentals continue to improve. In the industrial sector, "demand for warehouse space should remain healthy," Liang says. And lodging, which bounced back sharply in 2005, has a positive outlook, especially in the luxury segment.

The report also projects that a new supply of CMBS in Q1 "could provide an interesting test of how deep investor demand will be this year," Liang notes. Finally, "higher valuations and narrow yield spreads mean that increased volatility among REITs will likely persist this year as short-term traders move in and out of the market."

Instant Insights /

Report: Real Estate Return Could Decline in 2006

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