It is a challenge for me to speak to you today about some aspects of the real estate outlook for the United States in the next year. I am going to cover the general economic outlook only very briefly, and instead focus on real estate prospects, especially real estate finance.

The U.S. economy is in the midst of a general economic expansion different from the usual cyclical expansion. Growth is occurring in the midst of an unusual degree of global uncertainty, as shown by events in Iraq, world terrorism, and very high oil prices.

In addition, the twin U.S. deficits - that in the federal budget and in our balance of trade - are creating further uncertainty about the prospects of the U.S. dollar in world trade - and therefore in the future course of interest rates here at home and globally.

These uncertainties are slowing the growth of business spending on investment and job expansion, and producing mostly sideways movements in stock values. The same factors are creating uncertainty about the speed of interest rate increases. If growth gains more slowly than usual, interest rates will also not rise as fast as many expect.

Yet a sudden drop in the world's confidence in the U.S. dollar could cause a flight out of our currency that the Federal Reserve would have to combat by raising interest rates suddenly. So uncertainty is rampant in this sector too.

Another factor slowing the pace of our recovery is the immense impact upon world manufacturing costs of the entry of Chinese and Indian labor into the world's industrialized workforce, which has been going on for a decade or more. This dual entry has been almost a 30% growth in the world's industrial workforce at low wages.

That has shifted the labor supply curve to the right, holding down manufacturing costs and thus prices of manufactured goods worldwide. This was a deflationary force in world markets, keeping inflation low. That in turn pressured central banks to increase money supplies and lower interest rates to prevent broader deflation. The resulting low interest rates stimulated a worldwide surge in housing production and housing prices in all developed nations, including ours.

Ironically, the loss of jobs to foreign countries that Kerry complained about in the election has stimulated the massive rise in the prices of American homes, due to low interest rates. That increased the wealth of 67% of American households who own their own homes, and greatly stimulated their retail consumption.

Alan Greenspan and the Fed have now concluded that this deflationary force has run its course; so they want to reverse the long decline in interest rates from 1982-2003 that has so benefitted all real estate. The Fed is trying to move from cutting rates to raising ones, but so far it has not driven the long rate up.

The shift to rising rates would profoundly affect real estate markets. But the downward pressure on world prices caused by the entry of Asian workers into the world workforce has not fully ended. So that downward pressure on wages - including our own - is going to keep this recovery slower than most economists expect, thus slowing the negative impacts of rising rates on real estate.

A really important implication of these factors has been a dramatic rise in perception of real estate's desirability by both institutions and individuals. Skepticism about whether real estate is a distinct asset class has been replaced by unprecedented investor recognition of the virtues of real estate, both residential and commercial.

In reality, asset allocation is about perceiving the relative attraction of each asset class. Traditionally, those classes have been stocks, bonds, and cash, but real estate has finally achieved its appropriate role as a fourth major asset class.

Investors now recognize that real estate has recently outperformed both stocks and bonds, and its values have moved in time paths separate and distinct from theirs. So real estate is now seen as worthy of receiving a higher share of wealth.

Now let us consider both the causes of this change in perception that affects asset allocation, and its repercussions upon the prospects for real estate.

Why have investors re-evaluated real estate, reducing their past skepticism about its worth?

The answer lies in the relativity of asset allocation. The absolute qualities of any one asset are not as important in determining its desirability as are its relative qualities compared to alternatives. When REITs were doing extremely well in profitability and appreciation of their assets in 1996-1998, investors ignored them and put their money into internet and high-tech stocks because the latter seemed to be doing much better.

But this was an error, as shown by the stock market crash of 2000 through 2002. Suddenly, REITs and real properties - while actually suffering from deteriorating space market conditions - looked a whole lot better than stocks in general.

This shift was strengthened by the tendency of most investors to judge the near future by the recent past. Wall Street investors claim to be purely forward looking, but they actually look backward at recent results when trying to see opportunities ahead. Many were burned by stocks from 2000-2002, and are fearful it might occur again. So they don't bet on the come.

A second factor has been the dramatic decline in interest rates that occurred in part as the reaction of central banks to the stock market crash and the ensuing recession. That decline both slashed the return on bonds and cut the cost of borrowing to buy and operate real properties. This drop in real property costs helped offset rising vacancies and falling rents in space markets.

Another double blow to alternatives to real estate has been the high level of uncertainty in global affairs. That cut the allure of stocks when prospects seemed so risky. Another impact was the prospect that bonds would lose values if interest rates rose again, as the Fed promised and as usually happens during expansions. So tons of capital fled from both stocks and bonds into real estate.

Yet another weakened alternative to real estate is hedge funds. Investors desperate for yields have poured money into hedge funds to get better yields.

But the result has been a flood of over a trillion dollars into hedge funds. That over-funded the exotic investing ploys that the original hedge funds tried to beat the stock averages. As a result, as one expert put it, "Hedge funds are no longer a unique strategy for investing, but a wrap that their operators put over all types of uses of money to justify higher fees." So many hedge fund operators have begun shifting funds into real estate because more exotic derivative plays are no longer producing high yields.

You may think I have run out of causes for the basic rise in investor perception of real estate's desirability. But - Wait! there's more! Other positive factors have been improved transparency and better information in the real estate business itself, caused by Wall Street's entry into real estate via REITs and CMBSs, reducing technical obstacles to investing in property by more people.

So has development of new investment instruments, such as the private REITs exemplified by Wells, which are not bought but actively sold by intensive salesmanship based on high fees. These vehicles make it much easier for small-scale individuals to put their limited assets into real estate.

The final cause of real estate's enhanced attraction is that real properties, both REITs and direct ownership, pay relatively high dividends, compared to other assets forms. That has been especially attractive to individual Baby Boomers entering retirement and to pension funds needing cash to pay off their members who are retiring. This attraction will become even stronger in the near future.

The result has been a reduction in the risk premium formerly assigned to real estate as compared to stocks and bonds, or in relation to riskless instruments like Treasuries. So many investors have shifted large amount of assets from other things to real estate.

That brings me to my second basic question: What have been the past results of this shift of assets into real estate, and what are likely to be the near-future results?

The most obvious result, which has been with us for several years, has been an immense flow of financial capital into real estate of all types: homes, office buildings and shopping centers, REIT shares and CMBS issues. One lender summed it up as a "Niagra of capital" flowing into all types of real estate investments.

Billions, of dollars, euros, and other currencies have shifted from fixed-income investment funds into real estate. Other billions that might have gone into stocks in general have instead moved into real property. Yet there are still over $2.5 trillion in money-market funds paying under 2% interest.

This inflow of capital has had two major impacts upon real estate markets worldwide.

The first impact has been a global boom in housing prices. They have soared to record levels in all developed nations. U.S. median housing prices in current dollars have risen 43% nationwide from 1999 to 2004, and are up 123% in California in the same period. That makes them 2.5 time higher than U.S. prices.

This boom in housing prices was also aided by lower interest rates and easier borrowing terms from lenders. Many home buyers have almost no money down and are getting 5-year interest only, adjustable rate mortgages.

The second impact has been a massive disconnect in commercial property markets between space-market conditions - which until recently were getting worse through higher vacancies and falling rents - and property market conditions - where intense competition among investors was driving prices of well-occupied properties upward in spite of deteriorating fundamentals.

This disconnect has produced steadily declining cap rates for good-quality properties. Cap rates have fallen through the sevens, into the sixes, and are now flirting with the fives for shopping malls and top-quality apartments. Even with low interest rates, such cap rates tend to produce lower IRRs.

At the same time, poorly-occupied properties, or those with lots of rents that will roll over soon, are selling at much lower and even falling prices.

As the economy improves, this disconnect in commercial space markets is being partly offset by rising vacancy and at least stabilizing rents, except in office and R and D markets dominated by high-tech industries, such as Silicon Valley.

Just as this flood of equity capital has put downward pressure on cap rates and upward pressure on property prices, it has reduced debt spreads over risk-free U.S. Treasuries across the board, and is also beginning to loosen underwriting standards among lenders. The huge inflows of debt capital are driving spreads on all debt instruments downward, with little regard to the real degrees of risk involved.

Yet up to now, delinquencies and foreclosures on property loans of all types are still at very low levels. Loans most likely to be heading for trouble are those on high-rise residential condominiums in South Florida and Las Vegas, where high fractions of buyers appear to be speculators seeking to flip new units rapidly.

Surprisingly, this flood of capital has not yet stimulated a boom in new property development, which normally accompanies such a flood of money during a general expansion. The exceptions are in single-family homes, where construction has been at record levels, in life-style shopping centers, and in high-rise residential condos.

A major reason for this unusual restraint has been relatively low job growth. Many new developments, from office buildings to apartments to single-family homes, are usually closely related to local job growth. But job growth will pick up if general uncertainty gets lower next year. So then development may start up.

Another check on new development is the difficulty of getting entitlements for new projects. It now takes years to build most large-scale projects, especially where NIMBYs resist anything they believe might slow rising home values.

The attendees at a recent ULI symposium thought that capital flows into all types of real properties were likely to increase rather than slow down in the next year. Whole oceans of additional capital appear poised to come into real estate to escape the adverse prospects of other investments. Some thought REITs were over-priced, but others said several foreign nations were starting REIT markets with lots of capital.

One conclusion I have come to from all this analysis is that this is a great time to sell real properties. When people with tons of money are anxious to pay high prices in spite of poor underlying conditions, sell whatever you don't want to keep forever. No one can know the exact peak of a market, but I believe we are not far from it now.

Another good reason to sell now is that we Americans are now living far beyond our means, and we cannot continue to do so indefinitely. We are running huge federal deficits and huge trade deficits because we are not saving or taxing ourselves enough to pay for what we are consuming. And those deficits are bound to get worse as social security and medicare costs soar in the next few years. But we refuse to raise taxes or cut benefits or save more, and neither political party is even willing to discuss correcting this lunacy. So we are now living off the savings of low-wage Asian workers whose governments buy Treasury securities, and passing as many costs as possible onto our children.

This economic fantasy land cannot and will not last. So take advantage of it by selling any properties that appear close to their peak earnings or values now.

What changes in conditions might slow down these immense in-flows of money?

The most obvious candidate is rising interest rates. They seem likely next year both because the Fed wants to raise short-term rates, and because expansion of general businesses in an economic growth period normally raises competition for money.

Yet many observers, myself included, believe that interest rates will not rise as fast as normal because continued uncertainty and low foreign wages will slow overall growth below normal levels. Also, most attendees at that ULI symposium thought prospective money flows into property were so huge that moderate increases in interest rates next year would not slow money in-flows.

A second possible cause of change would be an exogenous shock to the world economy. An example would be a revolution in Saudi Arabia that put Islamic extremists in charge of that nation's huge oil supplies. Or the U.S. dollar might fall in value suddenly. In either case, interest rates would soar because uncertainty would get worse. Soaring interest rates could restore attraction to bonds and raise operating costs of real properties. It is hard to assign probabilities to this unpredictable factor.

An opposite type of change would be a sudden drop in uncertainty that stimulated fast economic growth and caused stock prices to take off. An example would be a sharp turn-around in Iraq with a stable elected government gaining defeating the insurgents, or some improvement in the situation between Israel and a new Palestinian leadership.

I started by saying that we are in a period of unusually high uncertainty around the world. And I ended by saying I am fairly certain this is a good time to sell real properties. I guess that shows what a paradoxical world we live in today.

But if we must have problems in life, and I believe all of us must, being in a business suffering from too much money looking for property is one of life's better problems - at least for people who own or sell property. So I will end with a story which shows the type of attitude we should all have under these circumstances - at least as long as these unusual conditions last. It is a story of a man who bought a parrot that could speak 5 languages (PARROT STORY).