These trends reflect a more cautious outlook on behalf ofprivate investors who in recent quarters have become concernedabout the degree of price appreciation over the past few years,historically low cap rates and the prospects of a slowing economy.On the other hand, institutional investors, which have structurallyshifted toward raising their real estate allocations, areconcentrating their acquisition activity on larger, top-tierproperties in primary markets. Another factor behind the increasein larger property sales is the privatization of large (major)REITs, mergers and the spin-off sales that have followed them.Lastly, larger private investors who have built up significantequity over the past few years are consolidating their equity outof multiple, smaller properties, to larger, more institutionalproperties. Many of these private investors are baby boomers whoare getting closer to retirement and their priority is shiftingtoward wealth preservation and income.

The common theme throughout the majority of the marketplace isstrength in valuation. While the rate of appreciation for smallerproperties has slowed significantly, pricing pressures and cap ratecompression are common for top-tier assets. Class B and Cproperties are experiencing more of a pricing gap and have seen amoderate increase in cap rates as a result, particularly insecondary and tertiary markets. Improving property fundamentals inmost sectors, balanced new construction and healthy rent growth aresupporting values and will continue to do so. As prices stabilizeand net operating incomes improve over the next 12 to 24 months,cap rates will move up moderately but are unlikely to return totheir long-term averages in the foreseeable future, since there isno cause for deep discounting of real estate prices.

In a low-yield environment, investors are clearly shiftingtoward emerging property types and value-add opportunities. This isleading many investors to seek opportunities in the office andindustrial sectors. Although the bulk of recovery in office marketfundamentals is in the past, the sector continues to offercomparatively strong potential for near-term revenue growth throughrent increases and further cutbacks in concessions. Cap rates foroffice properties continued to decline in early 2007 but areexpected to level off as the year progresses. Major coastalmarkets, such as New York, Los Angeles and San Francisco, couldprove to be the exception. Despite rapid price appreciation inrecent years, office property replacement costs in these marketsare still estimated to be 35% to 45% greater than sales prices, andrapid rent growth has been recorded so far this year. While theoutlook for the office market remains optimistic, investors wouldbe wise to keep a close watch on the development pipeline. Inmarkets that registered the greatest declines in homebuildingactivity, a downward correction in land prices andlabor/construction costs could prompt commercial developers tocommence new projects in the near term.