I. Today, I want to talk about a remarkable development that has occurred in the past decade. It is a huge inflow of financial capital into real estate markets the world over. This inflow of capital has been unique in my 50-year experience in real estate markets. I know you are all aware of this massive capital in-flow, but I believe it has transformed housing and commercial property markets in ways that are not all obvious. I have been so impressed by this money flow that I have just written a book about it entitled A NIAGARA OF CAPITAL. It will be published by the Urban Land Institute in October 2007.

II. Starting in the late 1990s and especially after 2000, a huge amount of financial capital moved into real estate markets worldwide, mainly from stock markets, which crashed spectacularly in 2000 after soaring throughout the 1990s. But there were also other major sources of capital contributing to the rush into real estate markets.

A. One source was the entry of millions of very low-wage but highly skilled workers into the world's industrial labor markets, mainly in China, India, and other developing nations. Their entry amounted to about a 20% expansion of low-cost workers into that labor force in under two decades. Industrial firms all over the world world could not raise prices, and were even forced to cut prices in many cases.

1. This kept inflation in check in the late 1990s and the 2000s, and even threatened to cause some deflation. So central banks increased liquidity in their economies to forestall deflation, raising money supplies. When stocks crashed in 2000, they also cut interest rates to block a recession. This too was favorable to real estate.

B. Another factor was an increase in global savings. Worldwide, profits were rising but firms, investors, and households were wary about expanding their productive capacities because of great uncertainty in the world's economy. That uncertainty resulted from economic stagnation in Japan, wars in Iraq, Afghanistan, Sudan and Serbia-Bosnia, the defeat of the European constitution in two nations, soaring oil prices around the world, and terrorist attacks in Europe and Asia. Also, Chinese households saved heavily because they had no government safety nets to rely on.

C. Yet another factor was the widespread adoption of securitization among lending institutions. Securitization permitted capital suppliers to reduce what they perceived as their risks from lending money. In the past, a lender took on the entire risk of any mortgage it financed. Under securitization, that lender divided the mortgage into multiple parts and sold then off to hundreds or even more investors, each of whom had a small piece of the loan. Each investor had many small pieces of many loans rather than a few big pieces of a few loans.

1. This arrangement was heightened by CMBSs, with their multiple tranches with different levels of risk and return. The Collateralized Debt Obligations (CDOs) came along that pooled CMBS loans and other types of loans into packages that were also securitized and sold off. As a result, every lender thought his or her risk was much smaller than it had been in the past. This led them to take on more risks and accept lower returns for doing so, causing more intensive competition among lenders, even lower risk premiums, and lower interest rates.

2. The Federal Reserve Board believes the under-pricing of risk is a central cause of the massive amount of capital available for real estate lending at low rates.

D. Real estate's attraction was also raised by the rapid aging of the populations in the world's developed nations. This both increased the flow of capital into pension funds, and caused the pension funds to want to invest in assets that are relatively stable and secure - including bonds backed by real estate. Aging also causes individual investors to seek assets that pay good dividends for their retirement.

E. Other positive factors have been improved transparency and information in the real estate business itself, caused by Wall Street's entry into real estate via REITs and CMBSs, reducing obstacles to real estate investing by more people. So has develop-ment of new investment instruments, such as private REITs like Wells.

F. One more cause of real estate's attraction is that real properties, both REITs and direct ownership, pay relatively high cash dividends, compared to other assets. That has been especially attractive both to retiring Baby Boomers and their pension funds.

G. But the most important source of financial capital gushing into real estate was the crash of major stock markets, starting in 2000. The internet bubble burst with a bang. All three major stock indexes started a two year collapse, furthered by the 9/11 attacks in 2001. They all hit low points on the same day - October 9, 2002. The Dow -Jones had fallen by 38%, S & P 500 by 49%, and NASDAQ by 78%. Since then, only the Dow-Jones Industrial Average - just 30 stocks - has fully recovered- barely!

1. Investors fled stock markets and poured their capital into real estate, which had by then recovered from its own crash in 1990. According to Peter Linneman, total capital entering U.S. real estate markets was between $150 and $200 billion per year from 1998 through 2002, then rose to an annual average of $239 billion from 2003 through 2006. That is a total increase of $1.783 trillion in nine years, after only $520 billion had flowed into real estate in the preceding nine years.

III. The resulting massive flow of capital into real estate markets worldwide had many major impacts that are still going on, and have restructured basic aspects of those markets.

A. The first impact was a basic paradigm shift in the attitude of investors towards real estate as an asset class, compared to stocks, bonds, and gold. After the 1990 crash in real estate, financial institution and other investors had avoided putting money into it. But when the 2000 stock crash occurred, investors decided that real estate was indeed a separate asset class in which they ought to hold capital, especially since its values moved in time paths different from stocks and bonds, and it had been more profitable. So many institutions raised their allocations to real estate from 3-5% to 10% or more.

1. Asset allocation is always an exercise in discerning the relative values and returns of various assets, not their absolute performance. REITs had done very well in the late 1990s but investors ignored them because internet stocks were doing so much better. But after 2000, REIT stocks took off since all other asset classes were in the tank and sinking fast. Hence the NAREIT equity index of REIT stocks shot upward. As of Mar. 12, that index had gained 332% since Jan. 3, 2000, vs. 8.4% for the Dow, -3.3% for S & P, and -41.8% for the NASDAQ.

B. The second major impact was a worldwide explosion in housing prices. All over the world, households rushed to buy homes because of low interest rates, easier credit terms, likely future capital gains, and no other good use for money. The massive supply of capital caused intense competition among lenders to ease credit conditions.

1. In the U.S., the NAR measure of median prices of existing homes rose 51% in 10 years from 1990 to 2000, then soared 60% in five years from 2000 to 2006. In California, home prices rose 135% from 2000 to 2005, and are 2.6 times U.S.

2. But home prices rose even faster in many other nations. From 1997 to 2006, home prices rose 158% in the U.S., but 244% in Ireland, 315% in South Africa, 184% in the United Kingdom, and 173% in Spain. In Japan, they fell 31%!

3. Higher home prices in the U.S. had three big impacts on housing markets. Most homeowners got wealthier from greater equity in their homes, which rose from $6 trillion in 1990 to over $20 trillion in 2005. This is ironic, because a major cause was that low-wage Chinese workers captured jobs from elsewhere. That blocked wage increases among U.S. low-wage workers, but made you all richer. Since 69% of U.S. households are homeowners, a majority of Americans gained.

4. A second impact on housing was to reduce - at least temporarily - household demand for rental units. People rushed out to buy homes on newly-improved credit terms for borrowers. The number of renter-occupied units actually fell by 1.7 million from 2000 to 2005. That increased rental vacancy rates for a while.

5. The third impact upon housing was to make it much less affordable to renters or others seeking to buy homes - even though easier credit terms enabled many to do so. Wages were held low by foreign low-wage competition, but prices soared. This is creating a worldwide problem for a large section of workers in developed nations whose wages are stagnant but their housing costs have shot upward.

C. The third major impact of the Niagara of capital was a broadening of the financial base of real estate markets, in terms of more globalization of capital sources, and of a wider focus of real estate investment on once-marginal properties, such as elderly housing, cold storage, casino hotels, and now even publicly-owned toll roads. This broadening is related to the paradigm shift making real estate more acceptable to more types of investors who are located all over the world, not just in developed areas.

D. The fourth major impact was in commercial property markets. There were three phases of this impact. We are just starting into the third phase now.

1. The first phase took place right after 2000, when the economy was slowing down, office vacancies shot up, and rents fell. But prices of well-occupied properties rose because so much money was looking for something in which to invest. There was a massive disconnect between conditions in space markets, which were worsening, and those in investment markets, which were going up. This disconnect was something wholly new in commercial property markets.

2. In the second phase, the economy was recovering enough to improve conditions in space markets. Vacancies declined and rents began to rise a bit. That caused property prices to rise even more as investors competed for properties with good yields. But rising prices drove yields down as cap rates plunged.

3. The third phase is just beginning. Investors and developers, discouraged by low yields on existing properties, are starting to develop new projects on which they believe they can get higher yields. If money remains available at low rates, this will lead to classic overbuilding, eventually cutting off the in-flow of capital.

D. The fifth major impact was an explosion of private equity funds because of the easy availability of very low-cost debt with which to leverage their private equity.

1. In the early 1990s, real estate had moved from primarily debt-financed, as it had always been, to primarily equity-financed through REITs, because sources of debt were cut off by federal regulation. The stock market forced REIT operators to maintain low debt ratios to avoid going broke as many had in 1989-1991.

2. In the current market, real estate is moving from equity finance back to debt financing through private equity funds. They are buying REITs and other forms of assets by hugely leveraging their equity base with cheap debt caused by the big inflow of capital into real estate, and into general investment availability.

a. Private equity funds require cheap debt both to buy assets and to sell them to others financed with cheap debt. If the current easy availability of debt financing were to dry up, so would private equity funds. If debt dried up before they re-sold their properties, many might be in big trouble.

E. A sixth major impact of the Niagara of capital upon real estate has been a drastic weakening of underwriting standards for investing in real properties. Intense competition among investors has forced cap rates down and loosened lending terms as property prices rose. As one major lender told me, "Underwriting standards have not weakened, they have plummeted." Another said, "They no longer exist!"

1. In the past few years, the most important underwriting of loans has not been based on the nature of the underlying property, but whether the lender can split the loan and sell pieces to others. A major CMBS lender recently said he kept any loan in his portfolio only 42 days; after that, he had sold it to others - it was then their worry. If you can split it up and sell it, it is seen as a good loan, regardless of the particular traits or prospects of the property concerned.

2. Competition among lenders for deals became so acute that many do not have time for due diligence before having to commit to a deal just offered to them. This intensity may be letting up somewhat recently, but it still exists.

3. Face by going-in yields on real estate loans and often equity lower than those on Treasury bonds, investors are driven to assume that future rents will rise on all properties much faster than expenses, and cap rates will not rise in the future -on very slim evidence - mostly a wishful projection of some recent trends.

4. Today, real estate is dominated by financial manipulators rather than experts in real property creation or management. At several major real estate meetings I attend, financial wizards outnumber real estate operators many times over.

5. Moreover, the splitting up of responsibility for money lent on any given property raises big obstacles to developing a work-out plan if anything goes wrong. Whom does a property operator consult with if default is looming? If there is another big overbuilding, as in the 1980s, recovery will be an even bigger mess.

6. Problems in the sub-prime mortgage market have recently awakened nearly all real estate lenders to the need for using more stringent underwriting standards, and temporarily slowed down their willingness to continue making loans that were so easy on borrowers. That is a good thing in the long run.

IV. All of this raises the question: how long will this Niagara of capital keep flowing into real estate - and other forms of investment? And what will happen if it ends?

A. I have formulated several scenarios about what might happen. I only have time to say a few words about each one.

1. If money remains easily available at low interest rates, which could happen in the rest of 2007 and into 2008, developers and investors will start a new development boom that will soon lead to overbuilding. That will drive property returns even lower and eventually halt the flow of capital into real estate. I personally think this is the most likely way that the Niagara of capital will slow down to more normal conditions. But many other things that might also happen

2. Interest rates might suddenly shoot upward, weakening ability to borrow. That could occur because of a disruption of world oil supplies, or a big drop in the value of the U.S. dollar. I do not foresee these events in 2007 or even 2008.

3. A sudden decrease in world uncertainty might cause the non-real-estate stock market to take off upward, drawing a lot of money back out of real estate. That could occur from peace in Iraq and Israel, settlements of nuclear power with North Korea and Iran, or other events that seem highly unlikely to me.

4. A disastrous event might disrupt world economic growth. Islamic extremists might revolt in Saudi Arabia and cut down world oil supplies, the Middle East might explode into a major war between countries not now fighting, or North Korea might attack South Korea. Such hard to predict events would disrupt the world-wide flow of capital, but also might make investing in the U.S. look good.

5. There might be a financial collapse of many hedge funds, or several major REITs might have economic troubles, or some other financial disaster might occur that disrupted investing in real properties. The sub-prime mortgage debacle has shown how quickly some relatively small problem in lending markets can paralyze the whole process of making capital available easily. But an even bigger freeze seems rather unlikely.

C. Some effects of the Niagara of capital will remain for a long time. I believe the relationship between incomes and housing prices has been permanently altered in ways adverse to housing affordability. The incomes of the lowest-income 40% are being held low by foreign competition, but homeowners will defend their new higher prices because of their political majority. Cap rates will remain low as long as interest rates are held low by the large supply of capital looking for a home.

V. On the other hand, I do not believe that the Niagara of capital and easy access to debt at low prices will last indefinitely. Nothing in this world lasts forever.

A. We in real estate have had an amazing and profitable run in world markets in the past decade that has made many of us wealthier than we expected. I suggest that you try to understand why that has happened - it wasn't just your brilliant personal genius - and prepare sensibly for the time when it stops happening. Good luck!