What typically drives up the cost of real estate is too many dollars chasing after too few properties. REITS have become, for many investors, their choice of investment. REITS are essentially mutual funds that purchase, manage and sell commercial properties. Depending on the REIT and the philosophy of the company managing the REIT, substantial prices are paid for properties even though the property's net return is somewhat conservative.

Investors have withdrawn from the stock market, in some measure, because the rates of return not only carry substantial risk, but also the market has under-performed in comparison to the real estate market. The problem with REITS is because they have so much capital, due to people investing in them, they are almost compelled to invest that capital into real estate. Their investments are forecasted over a 20-year period, and are based on somewhat variable and uncertain conditions. For example, they may forecast a 3% per year increase in annual rents. Running that increase in rents over a 20 year period results in a very high value of the property. Obviously, there is no guarantee they will be able to sustain a 3% increase in rents. Their primary tenant may go belly-up, merge, or be purchased by another company. Suddenly, this once class A tenant vacates 90% of an office building, and the owner has a real problem.

When Compaq merged with Hewlett Packard, they vacated hundreds of thousands of square feet of office space in the Houston area they once leased. In many cases, they're still liable for the rent. But retrofitting that space for a new tenant is very expensive, and there’s no way the owner can rent the space commensurate with the rates they were getting from Compaq.

Low interest rates and a stagnant stock market have contributed in very large measure to a rising market in real estate. Again, too many dollars being invested in REITS chasing after to few properties have resulted in spiraling prices for commercial properties.

It is likely real estate values won't crash commensurate with the way they did post Reagan tax reforms, pre S&L reforms and post oil glut as they did in the early and mid 80's. Properties during this time hit historical lows. S&L's took back huge portfolios of properties on foreclosure, and sold them at rock bottom prices. Nevertheless, it seems unlikely (to me anyway) that REITS cannot maintain paying these very high prices for real estate with the expectation they will return a profit in excess of the profits to be made by investing in the stock market. There's just so much profit a real estate investment can make, outside normal appreciation.

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