Last year I wrote several articles stating that the decline in REIT stock prices was not based on the profit performance of their real estate, but on the relatively poor record of real estate asset value increases during the 1900s compared with the prices of competitive stock investments, specifically technology stocks. I further predicted that REIT shares would not recover much until something drastic happened to technology stocks to dampen investor enthusiasm about their relative superiority to real estate. During the past few months, the truth of these assertions has been demonstrated.

Something drastic did occur to many technology and Internet stock prices, which have soared to unrealistic levels. As of mid-July, the NASDAQ composite average had declined about 20% since its high in February - though it was still 42.4% higher than a year before. The Dow Jones industrial average had gyrated spectacularly, plunging 16.7% from its January high to a March low, but it was still down 7.7% from that January high, 6.7% from a year earlier, and 4.0% since the end of 1999.

Meanwhile, real estate markets were booming because the economy was still expanding - thereby increasing demands for space. Moreover, the development and financing communities have been relatively restrained in responding to rising demand because they have refrained from any massive overbuilding of new space. Vacancies in some types of space have been rising. For example, office rents in downtown San Francisco have soared to unrealistic levels reminiscent of the Internet stock "bubble" - as have housing prices throughout the western portions of the Bay Area. But in most of the nation's commercial property markets, though space supplies have grown, there are no massive overhangs reminiscent of the late-1980s.

In addition, the investors who have been buying REIT shares recently are not motivated by the false belief that such shares are true growth stocks over the long run. Instead, most of these investors believe REIT shares are basically income investments, with a possible short-term appreciation play. That play has risen because in the recent past the lagging share valuations of the underlying properties have been "catching up" with the appraised values of those properties based upon their solid income performances. This has gradually reduced the discount to underlying net asset values that marked many REIT shares since the stock market drop in the fall of 1998.

These developments have moved REIT share prices closer to a long-term equilibrium with the profitability of the underlying real properties. This is evident from the 18.5% year-to-date total rate of return on REIT shares in the Morgan Stanley REIT Index as of July 7, compared with a -0.2% for the S&P 500 stocks and -2.6% for the NASDAQ composite in the same period. Over the prior 12 months, REIT stocks in that index outperformed the S&P slightly (8.5% to 6.2%), but were far below the NASDAQ composite total return of 45.0%. Even so, the abysmal performances of REIT shares in 1998 and 1999 mean that their total return since 1995 of 71.1% remains far below analogous returns from the S&P 500 (250.3%) and the NASDAQ composite (438.6%).

Moreover, most REIT share prices have not yet caught up to estimated market values of their underlying properties. Based on Merrill Lynch calculations of net asset value (NAV), as of early July, apartment REIT shares average 95% of NAV, neighborhood shopping center REITs, 95%; regional mall REITs, 78%; and office-industrial REITs, 87%. Yet, these percentages have been steadily creeping upward in recent months, and may rise further if neither of the two contingencies occur.

The first is dynamic recovery in high-tech or other non-real estate stock values. That would give investors another alternative to REIT shares that seem a lot more attractive, based on the long-term performance of property values over the past decade. The second is a marked deterioration of conditions in property markets - either through increased overbuilding, a slowdown in demand growth, or both.

I doubt if either of these adversities (from the viewpoint of REIT shareholders) will occur in the near future. However, the deterioration in real property markets is a lot more likely than the recovery in high-tech or other non-real estate stock values. Although no general recession is in sight, the economy does seem to be slowing, and that means more overbuilding is a possibility. But until either of these events occur, REIT shares should continue to rise relative to the rest of the market.