One of the biggest casualties of the global financial crisis is the big bust now underway in REITs, or real estate investment trusts. Until mid-2007, U.S. REITs dominated global investment performance in the post-2000 technology stock “bubble” era with eye-popping 25% annualized returns.

International REITs were even more profitable, especially for dollar-based investors as foreign currency returns boosted profits combined with rising dividend distributions. A blizzard of international and regional REIT mutual funds and exchange traded funds (ETFs) were launched since 2005 as global demand went off the charts.

Singapore and Western Europe spearheaded some of the most impressive returns over the last several years with eye-popping double-digit annual gains, including a profitable recommendation for one of Singapore’s largest and oldest commercial REITs two years ago in The Sovereign Individual.

The REIT Crash

Since the onset of the subprime mortgage crisis 14 months ago REITs have plunged in value – with the biggest declines occurring in Europe, Eastern Europe and Asia.

REITs have boomed recently in the Pacific whereby recent legislation was introduced permitting REIT structures over the last seven years in Japan, Singapore and Hong Kong.

But in Singapore, REITs have plummeted more than 15% over the last 12 months and are down in excess of 45% in Australia. In Japan, J-REITs have tanked almost 30% over the last 12 months and remain 25% off their best levels in the United States.

Too Much Supply, Lack of Credit

The turning point for REITs occurred in early 2007 as the “bubble” began to simmer following an enormous number of new offerings worldwide. Fueled by the lowest interest rates in a generation combined with easy credit, REIT sponsors went hog-wild.

Supply and demand always dictate price action for any secular trend; in this case, REIT initial public offerings or IPOs were all the rage across the United States, Europe and especially Asia starting in 2005. Any observant investor could have easily identified that trouble was brewing in early 2007.

The Big Squeeze

In addition to abundant supply, the ongoing credit crisis has also hit REIT values hard over the last year. That’s because REITs require a stable lending environment as developers and property managers require access to credit to expand or modernize existing properties. With even the highest quality of loan candidates struggling to raise capital this year it’s no wonder the sector has correlated almost perfectly with bank stocks.

In Asia, 2008 has been especially painful for REITs as the growing credit crisis, falling stock markets and plunging asset prices resulted in the cancellation of offerings.

Some smaller and mid-sized REITs are now threatened by questionable business models in the wake of a credit squeeze developing in the region where it has become much harder to raise equity and debt to finance deals. It’s the same phenomenon spreading to Europe and even fast-growing Eastern Europe as REIT values have collapsed. Even in red-hot China many construction companies have either failed or remain technically insolvent as the big real estate boom cools across many cities.

Beyond the Bear

The United States REIT sector might lead the rest of the sector to recovery over the next 12 months, assuming the credit crisis ends and banks begin lending again.

While U.S. REITs have shown signs of bottoming this year, regional REITs in Europe and the Pacific are still in the midst of sharp corrections.

Indeed, as economic growth slows across Europe and Asia over the next several months and more credit-related turmoil spreads to Europe, the United States is starting to look like a relative safe-haven. That’s because the ongoing credit crisis hit America first and with the latest passage of the bailout bill in Congress on October 2, markets might start looking at the United States REIT sector as a bell-weather ahead of a recovery.

Since July, the iShares Real Estate ETF (NYSE-IYR) has gained almost 10%, excluding dividends. It’s the same story for most banks over the same period, boosted by the Securities and Exchange Commission (SEC) short selling ban.

The U.S. REIT sector is worth watching carefully. The sector has already been trashed and, from a technical perspective, appears to have formed at least a short-term bottom in late July. Sentiment should improve following the bailout bill. Still, the country is now in an economic recession and the ongoing contraction might last longer than average recessions in the past because of the massive accumulation of debt and leverage-loan financing prior to 2007.

Pacific REITs will likely be forced to consolidate in the months ahead and that will pose regulatory challenges to corporate charters and shareholders. It’s too early to buy Asian REITs.

Europe, on the other hand, now faces a deeper credit squeeze as bailouts and a new wave of failures comes home to roost. The United Kingdom, Ireland, Spain and Denmark are all home to big real estate busts and it’s spreading. It is unlikely European REITs will bottom until at least late 2009.

Bigger Bargains in Spain, U.S. Foreclosures

For individual investors, especially dollar-based investors, the ongoing contraction in sun-belt values across the Spanish coast looks appealing.

The U.S. dollar is mustering a powerful bear market rally since its July lows and has already soared more than 13% over the last ten weeks against the euro. Combined with lower interest rates across the euro-zone later this fall or into 2009, financing costs should become more affordable for prospective buyers looking for a bargain in the popular Costa del Sol region.

In the United States, more government auctioned foreclosures loom in 2009 and that means big bargains for speculators and investors alike. Banks are desperate to remove non-performing loans in their clogged portfolio of real estate deals.

The last bear market in U.S. residential property in the early 1990s resulted in a plethora of deals for distressed buyers in Florida and California, among other states. This bout of real estate deflation now widespread across many regions and deepest in the American sunbelts of California, Arizona, Nevada and Florida will result in even greater bargains. It’s no wonder Europeans have been active buyers of U.S. real estate since 2007 amid a strong euro until recently. Now it’s time for Americans to buy domestic, too.