Real estate prices have increased over the last six to nine months and the demand for real estate is much greater than it has been at any time during the past three to four years. That demand is coming primarily from institutional investors, in the form of plan sponsors through advisers, real estate investment trusts and foreign investors. For the plan sponsors, given the fall in real estate values, the asset class represents approximately 3 1/2% to 4% of certain investment portfolios and many of the larger pension funds see the returns from real estate outpacing the returns from fixed income and equities over the intermediate period.

Large sums of money are again beginning to move into real estate from the plan sponsor community. Real estate is a capital-driven business. A plentiful amount of capital tends to create disequilibrium and it is difficult to regulate that capital.

Over the next year or two, signs point to a consolidation in the public company market, primarily the REIT market. A number of real estate players who converted from private companies probably should have stayed as private market players. They were not large enough to be as profitable as a public company given the added expenses of being a public entity and many of them have had a great deal of trouble adapting to the requirements of being a public company.

Merger talk between medium-sized companies is beginning to be heard in areas like the multifamily business and the community shopping center business. It is difficult to forecast significant consistent growth for a $200 million or $300 million REIT in one of these sectors of the industry. Single-asset growth at less than high velocity is slow growth. As a result, consolidation will be inevitable.

This consolidation could shrink the number of public REITs in certain sectors by as much as one-third, potentially, over a two- to four-year period. On Wall Street the various houses are trying not to do too many more transactions in the two sectors where they expect merger and acquisition activity. In sectors like hospitality, which is a new industry in terms of public market orientation, you are seeing renewed interest. In the hotel industry there is still an arbitrage left between the cost of capital and the yields that can be acquired. That arbitrage pushed a lot of the public market activity in the multifamily and the community shopping center businesses over the past several years. For instance, if you pay a 6% dividend but you buy property at 9%, that is a healthy arbitrage. The trouble now in the multifamily business is that yields have been pushed to 8% or lower, while the cost of capital has pushed to an equivalent level or higher. In the hotel business, however, you still see some arbitrage, at least for the near term.

Another trend is the merger and acquisition activity in the real estate pension fund advisory industry. This will continue to happen due to pricing pressure in terms of fees and the costs of servicing an equity portfolio, which has gone up due to the demands of investors over the past several years.

United Asset Management provided Heitman with the capital to acquire certain investment units of JMB and there will be more of those kinds of deals. Other combinations are being discussed.

Again, it gets down to the economic bottom line. On the asset volume that most are supporting, and the cost structure that it takes to support that volume, it is difficult to make money. There are two choices: either increase volume drastically or substantially downsize the cost structure. Both are happening.

In the real estate pension fund advisory business, the big are getting bigger and the small are getting more unique. It will be the middle-market players that get caught in the squeeze. The big guys are saying: "We are going to have more assets under management but we're also going to do a lot more things. We used to just manage office buildings and shopping centers; there's surely no reason we can't manage multifamily assets. There's no reason, by the way, that we can't manage REIT securities. There's no reason we can't do debt securitization."

This is occurring as a result of the general comfort with the client relationship. The pension fund advisers have heard directly from the clients that they trust the relationship and if they have the right people and the righ programs, there is no reason the funds won't invest.

The real estate industry has gone through the worst part of the cycle. It is a cycle where entrepreneurial capital will once again start pulling out of the business because it cannot achieve 30% compounded returns any more. Institutional capital, as mentioned before, will come back into the industry. That is not unlike what was seen in the mid-1980s.

Wall Street still owns a lot of real estate. They own it in the form of direct real estate and real estate loans, and there is a question as to what will happen to all that real estate. Somehow they will need to place that back into the system in order to achieve the returns that they promised to investors. They have financed it with securitized debt. They may sell it off to new buyers. There is a lot of real estate to be recycled and it will be interesting to see where the demand for that product will come from.

In the public capital markets, even though I have some personal doubts about the REIT side, I think debt securitization will be very much a part of the industry going forward. Capital will come sparingly from the insurance companies, while a lot of capital is coming from the banking institutions. There is capital coming in debt form from pension funds.

The big banking institutions and other financial intermediaries will play the role of mortgage banker. They will lend their capital, using it to create pools of loans, which they will then securitize. It will be a major part of the real estate finance business.

Approximately $500 billion dollars of commercial loans will roll over in the next several years. That is a lot of real estate. The banks are going to roll them over because they don't have a lot of choice or someone is going to have to do a lot of refinancing, assuming that prices continue to increase.