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No. of Recommendations: 4
Looking to the real estate investment sales market one see's sales prices holding steady or increasing (though volume of sales are down). Real estate fundamentals are off generally - decreased occupancy and rental rates. By definition this situation indicates that cap rates are declining.

Three possible reasons for a decline in cap rates:

1) Buyers believe the decrease in operating fundamentals to be an anomaly or will correct quickly;

2) The alternative investment argument - that few investments today offer the security and yield that real estate offers and buyers are paying up for these investments; and

3) Ralph's thesis (greatly simplified) that as the core inflation rate has declined to a new level, real rates of return have increased. As this new reality is understood by the marketplace - purchase prices can increase and investors will receive the same real rates of return they received in the higher inflation environment.

What does this mean for REIT NAV's?

Today's NAV estimates may not reflect the current market values of real estate and may be too low. Thus the premiums and parity we see for between REIT shares and their NAV may in fact be discounts to today's market value. Morgan Stanley alludes to this situation in one of their latest research pieces when they examined recent New York building sales.

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