By Ralph Block

REIT stock performance over the past four years has been nothing short of spectacular. But we curmudgeonly REIT investors are not inclined to boast, swagger or lay high-fives upon one another; rather, we are more sober and reflective. We love our newfound popularity but wonder whether our shining REIT coach will, again, morph into a pumpkin.

Those who've been surprised by REITs' performance against the backdrop of weak real estate markets now know that, "It's the capital flows, stupid." Investors of all stripes and descriptions have been allocating more of their assets toward real estate.

But saying REIT prices are being driven by "positive capital flows" is like saying that Maurice Greene won the 100-meter dash in the 2000 Olympics because "he was faster than his competitors." We need to understand these fund flows, including their persistence, strength and duration.

Some would compare 2003 to 1997. That latter year was the last in a string of strong years for REIT stocks, but was followed by two of the worst years in REIT history. Was 2003 déjà vu all over again? Will we enjoy a soft landing? Or will 2004 be yet another winner? We can only speculate.

Investment trends revert to the mean. The bear case is that this reversion is imminent, arguing that "This time it's different" is a claim made only by fools. And yet, to trade hackneyed expressions, "We shouldn't drive forward by looking through the rear-view mirror."

There are, indeed, similarities with 1997, including total returns beyond historical norms, strong capital flows, the formation of new mutual funds, an increase in stock offerings, the return of significant NAV (net asset value) premiums and a fair amount of exuberance (whether irrational or not is open to debate). But there are also many differences. The capital raised in secondaries is much less, NAV premiums are more modest, REIT management teams show increased discipline and investors' return expectations aren't outlandish.

But, even more important, the demand for real estate investments is more steadfast this time around. The baby boomers are approaching retirement age, and many will emphasize income over capital gains. Portfolio diversification is now almost a religion. Yields and the predictability and stability of cash flows are more highly regarded today. Institutions of all sizes seem to be allocating more capital to real estate (and REITs), and for the right reasons. Also, often overlooked, REIT management teams are clearly ready for "prime time." In short, as evidenced by S&P inclusion, REIT investing is now mainstream, and REITs are becoming a permanent part of investors' portfolios—yet are still under-owned.

Of course, capital flows will eventually ebb. This is the nature of the investment world. But my hunch is that when that day arrives, the money invested in REIT stocks will be much stickier than last time, and outflows from some will be offset by inflows from others. REIT returns may simply drift for a time, rather than looking, as they did in '98, like a tech investment gone sour.

In closing, after a three year absence I look forward to writing columns again for Real Estate Portfolio, and hope you will enjoy reading them.