No end in sight to the rise of the mighty REIT.

REITs posted impressive gains in 2006, maintaining a years-long trend of strong performance that has been largely driven by the influx of institutional capital into the sector.

NAREIT's U.S. REIT Index delivered 34.35% total returns for 2006.

With large funds still eager to boost their allocations into real estate and a busy pace of merger and acquisition activity that has exposed what some experts say is a widespread under-valuation of publicly traded REIT stock, analysts foresee a continuation of excellent returns for the sector.

The glowing predications stand in stark comparison to those of recent years, which seemed to grow successively gloomier despite the REIT industry's consistent double-digit returns.

"REITs have continued to defy gravity," said Matthew C. Gilman, chief executive officer & portfolio manager for Starwood Real Estate Securities. "And I wouldn't say that the bull run on REITs is over. Real estate fundamentals have been strengthening and supplanting the slower pace of asset appreciation. Generally there remains tons of capital that wants to find a home and increasingly investors are still turning to real estate. When you have institutions wanting to invest in real estate, they often do it through REITs because it's easier and more liquid than direct investment or other vehicles."

Some analysts postulated that real estate values would recede in the face of rising interest rates and consequently hurt REITs' net asset values, a principal measure used to determine the price of a REIT's stock. That scenario has yet to unfold, of course, as long term interest rates have inched up negligibly in the past year and the Federal Reserve has shifted gears from raising and then pausing short term rates to possibly now cutting them in the face of anemic economic growth.

If anything, the record breaking level of M&A activity in 2006 showed that the public market has underestimated REIT net asset values. Experts say that while The Blackstone Group's $36 billion purchase of Equity Office Properties in November seemed like an eye popping price to pay, the private equity giant will likely be able to effectuate an arbitrage by dismantling and selling off the portfolio piecemeal at a profit over the next few months.

The gap in REIT pricing between the public and private markets is expected to shrink in 2007, but not vanish. Private real estate investment firms have an inherent ability to pay more for real estate assets than public companies because they are typically freer to use higher amounts of leverage.

Incurring such debt allows an owner to yield more cash flow from an investment, but REITs are under pressure to pursue less aggressive financing strategies because of their limited tolerance for risk.

Analysts say this will allow the M&A activity to continue, albeit at less of a disparity. This trend alone has drawn investors to put money into REITs with the hope that a private institution will pay a premium on their share price in an effort to make an acquisition. The privatization of

REITs, especially those as big as EOP and Trizec, has caused some alarm among market observers however, who fear that continuation of the trend could eventually put a dent in the sector's market capitalization and diminish its attractiveness to its essential clientele, institutional investors who wield the billions of dollars that have supported the industry.

NAREIT economist Brad Case said that this possibility would likely be countered by an opposing industry trend.

"What hasn't been talked about is the amount of REIT IPOs that have happened that have essentially replaced all the REITs that have gone private," Case said.

"Overall, the REIT industry has continued to grow, which is part of what continues to make it an attractive investment vehicle for the large investors."