The Future Role of REITs in Real Estate Finance

Anthony Downs

Major and somewhat conflicting changes in the roles of real estate investment trusts
(REITs) in commercial real estate finance have occurred in the past few years. Before 1990,
REITs played a relatively insignificant role in financing commercial real estate. But in the early
and mid-1990s, REITs rose dramatically in prominence. By 1997, although REITs still owned
only a small percentage of all existing commercial properties, they actually dominated current
transactions in many commercial property markets. Yet REIT share prices began lagging the
still-rising general stock market early in 1998. Then, in the fall of 1998, when the overall stock
market dropped sharply, REIT shares also plunged. However, they have not recovered along
with most of the rest of the market, even though most real estate properties themselves are still
doing well.

These changes raise questions about the future roles of REITs in financing and operating
commercial properties in the U.S. This article contends that the recent shift of much of on-going real
estate equity and debt financing from traditional, purely private markets to securitized, public markets
has changed the attitudes of investors towards commercial real estate in general. Their change in
attitudes is unfavorable to the real estate industry under many economic conditions, including those
prevailing in early 1999. This article explores these changes and discusses their implications for the
future of commercial real estate in general and REITs in particular.