Real estate observers in the US are questioning whether the sector has come to the end of an eight year bull run. So far the downturn has hit the indirect investors hardest, with share values of Real Estate Investment Trusts (or REITs) slashed. While for those with the confidence and financial muscle to play the direct market, values have held up rather better. So what are the options facing European investors who want exposure to the $20trn (Ecu36trn) industry that is American property?

During the 1990s REITs have been the undoubted success story of US property. They are effectively tax-efficient versions of quoted property companies, paying tax only on shareholder dividends. Between 1990 and 1998 the number of REITs listed rose from less than 20 to more than 200, and the market capitalisation of the sector exploded from $9bn to $150bn.

According to David Marks of Jones Lang Wootton this boom was fuelled by a combination of tax efficiency, low cost of capital, cheap buying opportunities and a long term institutional trend away from direct asset ownership in favour of indirect vehicles.

This massive shift of money into REITs came as a challenge to many of the traditional real estate fund managers: their clients were naturally attracted by REITs sparkling performance (in 1996 the sector as a whole produced a total return of 36%) and their greatest asset was their liquidity. Traded on the main US stock exchanges, they overcome one of property's greatest drawbacks which is the time and cost of dealing.

Most, like the long-established Heitman Financial and the younger but fast-growing LaSalle Partners, were forced to become more entrepreneurial, providing services to the REITs themselves. These ranged from negotiating development and acquisition finance through to construction and property management. It has undoubtedly been profitable business: LaSalle has recently announced the acquisition of the London-based Jones Lang Wootton.

One of their key roles has been running managed funds to hold baskets of REITs. The influential Dutch investors, who have been leading the way into indirect investments, are reputed to have bought as much as $1bn of REITs.

However, it now looks as though, temporarily at least, the gloss has gone off REITs.

According to LaSalle Partners' 'Market Watch' research for the third quarter of 1998, REITs have been hit by a combination of negative factors. First came a tightening in the property debt market, which REITs need to tap to fund their operations since they are legally obliged to distribute 95% of profits to shareholders. Some fear this is now heading into a full-scale credit crunch, since Federal Reserve officials visited several key property lenders and warned them against becoming over-exposed to REIT borrowers.

And second came the stock-market slump at the end of August which knocked a further 10% off REIT prices. This devastating one-two left REITs on the ropes.

But LaSalle points out that this sudden shift in sentiment is not reflected in the actual property markets: the assets which underlie REITs are still performing.

This year, for the first time since 1983, less than 10% of all office buildings in the US are vacant. While this does not look like a shortage by European standards, rents are still rising faster than inflation.

In the industrial sector vacancies nationwide stand at 7.1% and over the past year rents have grown by 5.3%. However, with a surge in development activity and short construction times there is potential for supply to grow and rental growth to slow.

Apartment buildings typically form a substantial part of US property portfolios, and here vacancies are running at around 5% while rents grew by 3.1% in 1997.

In the hotels sector the picture is less bright, with a surge in construction bringing new hotel rooms to the market at a time when business executives are just beginning to cut back on travel. Average occupancy levels in US hotels fell during 1997 to 64.5% and they are expected to reach 61% in three years' time.

Only in the retail sector is there current cause for concern, and this is due to the functional obsolescence of many older secondary shopping malls as much as to any cut-back in retailers' expansion. From a low of 7.6% in 1994, retail vacancies are now back well above 10% and accordingly rents are virtually static.

But as much as sector performance, LaSalle's case for US property is based on economic fundamentals. The amount of new capital being invested in real estate is below the level at the peak of the last cycle in 1987. It is still rising but at a relatively slow rate. New construction volumes are still relatively low, although they are rising. Finally, property yields are much higher than they were in 1987 or 1988 even though US interest rates are much lower than at that time. The result is that many more property acquisitions are self-financing and do not have to generate capital or rental growth for an acceptable return.

So which set of observers are correct? The quoted REIT market is in disarray while the direct property market is still moving ahead steadily. REIT share prices are a forward-looking measure, reflecting investor sentiment about future growth prospects and the bears would say that their decline presages a downturn in direct property values.

But the big danger for US property is that this might turn out to be a self-fulfiling prophecy. REITs now own 8% of all US commercial investment property, and even as recently as last spring some were forecasting that this number would grow to 50% within 10 years. With their access to debt finance curtailed and nobody wanting to take new paper, REITs are finding it almost impossible to make new acquisitions. With such a major group of players out of the market, capital values of direct properties could just take a turn downwards regardless of the fundamentals.