A. REITs Beat Major Stock Indices in 2005, Again
B. Economic Expectations for the Coming Year
C. REITs and Real Estate in 2006
D. Equity REIT Performance
E. Large Cap REIT Performance
F. Mortgage REIT Performance
G. Realty Corporations
H. Real Estate Mutual Funds

A. REITs BEAT MAJOR STOCK INDICES IN 2005, AGAIN
For the sixth straight year, REITs have outperformed most stock indices. With the Dow Jones total return of 1.9% and the S&P up just 4.9%, most REIT indices showed overall returns of around 10%. Of course, some property type groups and sectors performed better or worse than others. For example, Mortgage REITs, which achieved better gains than Equity REITs when rates were dropping between 2001 and 2003, have underperformed for the past two years in a row as interest rates have increased, posting a loss of -18.68% in 2005. Of the dozen property type groups containing about 200 REITs covered by RealtyStocks, only two groups were negative for the year and the two best performing groups, Self-Storage and Regional Malls, gained 20.78% and 17.85%, respectively. Of nearly a dozen Realty (& Housing) Co's. groups covered, only one (Home Builders) suffered a loss (of -15.62%). The best performer was Lodging with an exceptional increase of 41.19%. Realty Co.'s had an overall gain of 15.33% for 2005, with nearly all groups posting double-digit gains.

Several factors contributed to respectable gains in 2005, outpacing the broader equity indices. First, interest rates are remaining low, helping both the value and performance of REITs and Realty Co's. Second, the economy is performing fairly well increasing user demand across most property type groups, while the supply has been relatively restrained. A third theme we have espoused before, is that as the Baby Boomers are getting closer to retirement, and are more concerned with better dividend returns, REITs will become more attractive as compared to other investments. Finally, a relatively new trend that began about two years ago, is the acquisition of REITs by private investors (i.e. the privatization of REITs) which has taken away about $20 Billion in REIT assets. These factors, along with mergers and impending mergers, have shrunk both the asset base and number of larger REITs. Hence, as the supply of REIT stocks dwindle, the share prices of REITs should improve, as long as the demand for REIT shares stays constant or increases.   Top

B. ECONOMIC EXPECTATIONS FOR THE COMING YEAR
Perhaps there are more mixed signs about the economy this year than last. Some recurring themes of high oil prices, higher interest rates, slower corporate earning growth, inflation concerns, illegal immigration, increased tensions in the Mid-east as well as other parts of the world and possibly global health epidemics, e.g. the bird flu - could potentially have a great impact upon our economy this year. Furthermore, there is the renewed threat of terrorism due to the recently released remarks from Osama Bin Laden - who is still at large. Interest rates have increased significantly last year for short term rates, but are expected to top out by mid-year. In the near term, the rate inversion (where short-term rates are higher than long term rates) may widen, concerning many economists, as it is normally an occurence just before a recession. The long awaited housing slow down could cause the increase in housing prices to diminish, and possibly decline. This could have a negative impact upon consumer expenditures, which have been the major driver of our economy. Tensions with China over trade and human right issues appear destined to escalate as the national deficit swells. Domestically, the crisis of our domestic automakers and airlines will cause more layoffs and place more pressure upon pension funds and retirement benefits. Along with sky rocketing increases in health care, Medicare and Social Security - the prospects for taking care of aging Baby Boomers will exacerbate and any prospects for balancing the national budget in the foreseeable future.

Such concerns as noted above are making many investors skittish about the forecast for equities. This is causing a great deal of money to be parked in short term securities, yet still looking for better returns. The enormous budget surpluses of other countries causes them to be major buyers of our government bonds. This combined with pension programs, which are also active buyers, is keeping our longer term interest rates down. However, foreign bond purchases and holdings makes bond investors nervous because if such countries loose their appetite for our bonds, it will cause long term rates to rise and bond prices to drop. With regards to real estate, reproduction costs seem very unlikely to go down, especially with rising commodity costs. This may have contributed to investor's rationale to bid up commercial real estate prices and at the same time lock in a hedge against inflation, while beating the dividend returns from most stocks and bonds.

For the past decade, there have been concerns over a stock PE ratio that is too high and a dividend yield that is too low from a historical perspective. As a result, many investors believe equities are over valued. In relation to the measure of commercial real estate's value, capitalization rates (income divided by price) have changed even more from a little under 9% to about 6% for many asset classes. As we discussed previously, current returns allow little risk premium for lease turnover, vacancy, major remodeling and obsolescence. Therefore, the prices of commercial real estate are at levels that many experienced real estate professionals believe are unsustainable. It appears we could be entering an environment where appreciation for equities, real estate and even housing may begin to turn, or at a minimum moderate, while the prices for commodities continue to rise. Even though the U.S. currency has remained strong globally this past year, when the increases in our rates stop, it could make our currency vulnerable again. As a result, the strong gains in stocks over the last few decades, averaging nearly 10% annually, may fall short of past performance. Further, when adjusted for currency fluctuations, they could be even worse. The negative implications from this are numerous. Top

C. REITs and REAL ESTATE in 2006
Large Cap REITs outpaced the gains of the broader REIT market for a second straight year in 2005. It has also caused dividends to drop under 4% on most large caps. With short-term rates a full percentage over this and with less capital risk than with REITs, it may sideline more investors from REITs this coming year. That being said, the privatization of REITs mentioned above should be positive for REIT share prices. Already this year, REITs have shown a nice price increase of a few percent.

With the returns of the larger REITs below 4%, yet the yields on most commercial real estate over 6%, it seems that the trend for the privatization of REITs is more inclined to involve smaller REITs where the yields are higher. A further rise in REITs would also seem to make the privatization of REITs less likely. However, we do see the prospects of some more mergers and acquisitions and even more REIT IPOs in 2006 to be more likely. Even though large cap REITs have outperformed those smaller REITs, with a gap of over 200 basis points between the yields of such REITs, we could see a greater capital gain opportunity in smaller REITs this year. We also expect greater opportunity among some property type groups than others.

A relatively mild January was attributed to an increase in housing starts last month. However, home builders are starting to report more indications for a sales and building decline, which was widely expected. The past couple of years the housing market has defied predictions of a slow down. Now that the slowest part of the year has nearly past, the sales and housing starts for the coming months will be more meaningful. Of course, what is most important is how housing prices will fare, which could have a major impact upon consumer expenditures, as previously noted.   Top

D. EQUITY REIT PERFORMANCE
Equity REITs lost momentum in the fourth quarter of 2005 with overall gains of -0.85%. After sustaining a loss throughout all property type groups in October and a drop of -2.62%, REITs bounced back in November with a gain of 2.79%. However, in December most property type groups were again negative and the overall loss for the month was -0.83%, about the same for the last quarter. For the fourth quarter, the best performers was Regional Malls with a gain of 5.25% while Specialty performed the worst with a loss of -10.72%. For the 2005 year, only three groups were negative with Specialty and Malls/Centers suffering the worst losses while another subgroup of retail, Regional Malls, performed the best with a gain of 17.58%. Overall, Equity REITs gained 2.55%. Combining dividends of a few percent, we estimate that the broad based overall returns for REITs was around 8% for 2005. (Please see Equity Gainers and Losers.)   Top

E. LARGE CAP REIT PERFORMANCE
Large Cap REITs finished the fourth quarter stronger than the broader REIT market with a slight gain of 0.8%. Large caps fell -2.2% in October, rebounded 3.9% in November and fell in December -0.9%. What distinguished large caps in the fourth quarter from the broader REIT market was a larger November gain and a smaller loss in October. Out of two dozen Large Cap stocks, only a few were positive in October, all but 1 (Boston Properties) were positive in November and most were negative in December. The best performing stock for Q4 was Marriott (HMT) with a gain of 12.1% and the worst was iStar with a loss of -11.8%. For 2005, Large Caps gained 7.4% and beat the broader REIT market by over 5%. However, dividends for large caps typically vary between 3.5% and 5.5% and are between 1% and 2% less than the smaller REITs. Overall returns for Large Caps were therefore around 12%; a few percent better than the broader market. The best large cap performer for 2005 was General Growth (GGP) with a gain of 30% followed by Public Storage, Trizec and AMB, all with gains of 21%+. The laggard for 2005 was iStar Financial (SFI) with a loss of -21.2%. Please see Large Cap REITs.)   Top

F. MORTGAGE REIT PERFORMANCE
Mortgage REITs again grossly underperformed Equity REITs with a loss of -6.24% in the fourth quarter. October and December showed negative gains of -4.81% and -1.92%, however, November showed a slight gain of 0.56%. The best group in the fourth quarter was the Mixed group with a loss of -3.88% while Commercial Mortgages were the worst with -7.82%. Interestingly, the best groups for 2005 were reversed with Mixed losing -22.24% and Commercial loosing -13.86%. Overall, Mortgage REITs lost -16.94%, their first loss in several years, underperforming Equity REITs for the second year in a row. As mentioned previously, Mortgage REITs benefited from dropping rates in the beginning of this decade, but have performed poorly the last couple of years as rates have increased. (Please see Mortgage Gainers and Losers.)   Top

G. REALTY CORPORATIONS
Realty Co's. showed a loss of -4.1% in October, a gain of 5.73% in November and a gain of 1.34% in December. All groups were negative in October, all but one (Mobile Home Makers) were positive in November and December was mixed. For the fourth quarter, Realty Co's. gained 2.89%, outperforming REITs for all quarters except Q2 in 2005. The best group in Q4 was Tech & Net with a gain of 18.95%, while the worst was Home Builders with a loss of -7.77%. For 2005, the best performing group was Lodging surging 41.19%. The only group posting a loss for the hear was Home Builders with a loss of -15.62%. After posting stellar gains in 2003 and 2005 of 52.13% and 38.16%, Realty and Housing Co's. cooled to a gain of 15.33% in 2005, but still beat REITs. However, once dividends were included and overall returns considered for REITs, Realty Co's. advantage was more modest. (Please see Realty Corp. Gainers and Losers.)   Top

H. REAL ESTATE MUTUAL FUNDS (REMFs)
REMFs lost -2.57% in October, gained 6.25% in November and were just missed breaking even at -0.03 in December. REMFs actually performed better than REITs in the fourth quarter. For 2005, REMFs had an overall return of 11.8% and performed similar to the Large Caps, but outdistanced the broader REIT market. A year ago, we were concerned that many REMFs would be overweighted in Home Builders, which would underperform the market causing their overall returns to lag. Even though average overall returns for REITs was better than the overall market, the returns for most REITs and the median performance may actually be a little lower than the noted average. Also, these average returns were also helped by REMFs with foreign investments. For instance, out of 256 REMFs, two of the top four REMF performers were International funds. The Top REMF for 2005 with a gain of 26.94% was CGM Realty followed by E.I.I Int'l with an overall gain of 21.01%. (Please see REMFs.)   Top

Stock Changes. Capital Automotive Realty (CARS), American REsidential Inv. Trust (AMNT) and West Coast Hospitality (WEH) have been deleted. Catellus Development (CDX) merged with ProLogis and was also deleted.

Note: In reporting group percentage changes, stocks that were under $1 are excluded from our calculations. If a stock is under $1 for more than two months, it is subject to removal from our coverage. All gains or losses regarding Realty Stocks are price changes only; dividends are excluded, and are calculated as of the end of each month.