After accelerating each year since 2001, the flow of investment capital into REIT mutual funds slowed precipitously in 2005. Although positive, the $1.8 billion inflow total for 2005 marked a 76% reduction from the record $6.9 billion that entered the sector in 2004, according to AMG Data Services based in Arcata, Calif., which tracks mutual fund money flow and holdings data.

Some real estate watchers use AMG’s data as a barometer for the larger market of investments in REITs and commercial real estate. In that sense, the retreat from REIT mutual funds could reflect waning investor interest in commercial real estate investments.

With much of today’s high property values predicated on investors bidding up prices, a reduction in investment dollars chasing deals could conceivably bring reduced values for properties, or reduced share prices for REITs.

But real estate economists and researchers say it’s too early to conclude whether large numbers of investors are beginning to divest REIT shares. And relative to the $335 billion U.S. REIT market, the fourth quarter’s outflow represents only a fraction of a percent.

“What’s significant is that the annual flow is still positive,” says Jamie Woodwell, senior director of commercial and multifamily research at the Mortgage Bankers Association. “You’re not getting a record increase in 2005, but you’re still seeing more money coming into the market. All that money that came in the previous years is still there, plus some.”

Woodwell cautions against reading too much into the recent negative flow of funds. Most other industry indicators, such as CMBS issuance volume and direct investment totals, suggest the demand for commercial real estate investments is as strong as ever, he says.

The recent outflow of capital from REIT mutual funds is surprising, but isn’t likely to continue in 2006, says Dan Fasulo, director of market analysis at Real Capital Analytics. “I don’t think there’s any way not to have positive inflows this year,” he says.

“For one thing, more and more companies are offering REITs as an option on 401(k)s, so more individuals will be adding that into their plans.”

How do observers reconcile last year’s reduced fund flow with otherwise positive market indicators? One explanation may be that investors are drawing off earnings from the REIT industry’s six-year run of outperforming the S&P 500, says Keven Lindemann, director of the real estate group at SNL Financial LLC in Charlottesville, Va.

“In more than half of those weeks with negative fund flows last year, they were more than offset by market gains,” Lindemann says. “On Oct. 19, for example, there was an $86 million outflow, but the market was up $600 million that week. So parts of these outflows are just investors taking some money off the table in a strong REIT market.”

Lindemann and Fasulo both say the fourth quarter’s negative fund flow may reflect investor disenchantment with REIT share prices, indicating that investors are pulling out of REITs in order to invest directly in real estate assets.

Average share prices are about 15 times funds from operations per share and well above the historical average multiple of eight to 10, but share values are low in relation to the value of a typical REIT’s assets per share.

A number of high-profile REIT privatizations in recent months supports the idea that REITs are undervalued on the public markets, Lindemann says.

“Those companies went private because the feeling was that the public market wasn’t valuing public REITs properly, and that the collection of real estate in the REIT had a higher value on the private market.”