For investors, the 1990s were the decade of the booming stock market, while commercial real estate went through a virtual depression, followed by recovery. In spite of rising rents, occupancy and market values in the last half of the decade, the relative attraction of commercial property paled in comparison to that of corporate equities — especially high-tech and internet firms. But so far in the 21st century, the stock market has been on the ropes, whereas real estate markets have boomed.

Has this turnaround changed the relative allure of commercial properties, compared with stocks, in the minds of institutional and other investors?

The rocky ’90s

At the beginning of the 1990s, the total market value of all commercial real property was about the same as that of all corporate equities. But real property prices plunged in the overbuilt phase of the real estate cycle from 1990 to 1993; whereas the stock market soared throughout most of the decade.

According to Federal Reserve data, the total value of corporate equities rose from $4.9 trillion in 1991 to $19.6 trillion in 1999 — a gain of 300%. Even though real property prices recovered smartly in the last half of the decade, they did not have anything like the huge net gain of equity prices. Consequently, by the end of the 1990s, the total value of corporate equities was immensely larger than that of all commercial properties combined.

These events convinced most institutional investors that real estate was a second-class investment. That is why pension funds as a whole had 65% of their financial assets in stocks and mutual funds in 1999, but held less than 4% of their total assets in commercial properties, even though the total market value of all such properties is a much higher percentage of all privately held assets.

After stock prices dropped sharply in late 1998, the share prices of real estate investment trusts (REITs) did not recover along with much of the rest of the market in the boom of 1999. Apparently, the broader investment community concluded that real estate — even in the relatively liquid form of REIT shares — was not as attractive as other sectors, especially high-tech and Internet stocks. Yet the private market prices of commercial properties did not fall; in fact, they rose in many markets. This shows that there is still a two-tier pricing system for real estate: one public and one private. I said then that REIT shares could not regain their allure until stocks in the high-flying tech sector took a nosedive — which they did in 2000.

As the high-tech sector plummeted, REIT shares held up well and private market prices of commercial properties rose steadily. Investors were recognizing (1) that real estate was less volatile than other investments, though the volatility of REIT share prices is higher than that of the market values of privately owned properties, (2) that the market values of real estate assets move in a different time pattern from those of stocks in general — even REIT share values moved differently this time, and (3) that real estate values were less likely to fall off a cliff in this general economic cycle than they had been at the end of the 1980s.

By April 2001, the Nasdaq composite had dropped in value by more than 50%, and the Dow Jones was off more than 20% weighted by market value. What will be the impact of these events upon investors' view of the relative desirability of investing in commercial properties?

The answer depends upon the investors' time horizons.

Those with short-term horizons may conclude that the stock market has already fallen as much as it is going to, whereas real estate property prices have not been affected much yet by the current economic slowdown. Therefore, near-future prospects for a significant value rally almost look better in the stock market than in real estate, if you believe that stocks will not fall even farther. Of course, there is no certainty that stock prices will recover quickly from their recent declines, especially if the economy in general does not recover rapidly and corporate earnings therefore stay low or falling.

Meanwhile, although real estate values in private markets have passed their peak in this cycle, they are not likely to drop nearly as precipitously as many stocks have — or as they did in the early 1990s — because most property markets are not seriously overbuilt. True, an overbuilt phase of the cycle will surely follow the development boom that lasted from 1997 through 2000. But this overbuilt phase — and the gradual absorption phase following it — will be relatively mild unless the economy goes into a really severe recession. So in the near future, real property prices will exhibit a lot less volatility than stock prices.

In the longer run, real property seems likely to produce about a 9% to 10% return overall. Corrected for a 3% inflation rate, that is a real return of about 6% to 7%. The long-run return from corporate equities has also been about 9.5% to 10% in current dollars. But it has been higher in the past few years, and most investors expect it to remain significantly higher in the future, according to some recent polls. Even so, the long-run real return from commercial properties is comparable to that from stocks. True, real properties are less liquid than stocks if owned directly, but their values are also less volatile — unless markets are flooded with overbuilding, which at present they are not.

Moreover, investing in commercial real estate is an effective means of diversifying an institution's assets, since the timing of property price movements is different from that of stock price movements.

As of late 2000, corporate equities and mutual funds together comprised about 65% of pension fund financial assets (including both private pension funds and government retirement funds), up substantially from 40% in 1991).

With real properties comprising less than 4% of those assets, it appears that a shift of some pension resources from the stock market to commercial property markets makes a lot of sense. That should be a favorable factor for REIT shares too, since using them is the easiest way to invest in commercial property markets.

Anthony Downs is senior fellow at the Brookings Institution in Washington, D.C. The views in this article are those of the author and not necessarily those of officers, trustees or other staff members of the Brookings Institution. You can contact the columnist directly through e-mail at