At the open of trade on Thursday, real estate will be set free.
The S&P Dow Jones Indices and MSCI will give real estate its own unique class, separating it from the gang within the financials sector. The parting of ways comes as real estate as a sector has outperformed the S&P 500 with S&P’s REIT industry index up 24 percent annually since the bull market began in 2009, versus 18 percent for the benchmark.
The new classification will include all real estate investment trusts (REITs) with the exception of mortgage REITs, which will remain classified under financials.
Being a standalone category is a double-edged sword. The new classification will attract passive investors looking to track a new major sector of the market and may bring in new money from active investors who may not have been aware of the sector’s strong performance. But memories of the real estate crash and the mortgage crisis in 2008 may be enough to deter some investors, rightly or wrongly, who still see real estate as risky.
“Reclassifying REITs and real estate operating companies (REOCs) into a standalone sector, apart from providing a more accurate description of the companies themselves, will likely raise the profile of real estate fundamentals overall,” said Jamie Anderson, managing partner of Tierra Funds, which offers the Tierra XP Latin America Real Estate ETF.
REITs have outperformed the broader markets because they are a strong dividend play in a low-yield environment. REITs are required to pay at least 90 percent taxable income annually in the form of shareholder dividends; real estate stocks today provide 7 percent earnings growth and 3-plus percent dividend yield. In addition, the fundamentals of the commercial real estate market, especially the industrial, apartment and office sectors, have seen a strong recovery since the recession. Their classification under financials may not have highlighted that strength.
Technically, what is happening is that real estate will be its own category in something called the Global Industry Classification Standard structure, a guidepost of sorts for the global financial community. This marks the first time a new sector has been created under the GICS structure since it began in 1999.
“This is the first significant structural change to GICS sectors since its inception and reflects the position of real estate as a distinct asset class and a foundational building block of a modern portfolio, rather than an alternative,” said Remy Briand, managing director and global head of research at MSCI. “GICS was developed as a means of standardization that would keep up with the evolving investment landscape.”
The change was first announced last spring. “The creation of an eleventh sector recognizes the growing importance of real estate in the world’s equity markets,” said David Blitzer, managing director and chairman of the index committee at S&P Dow Jones Indices, in the announcement at the time. “The decision to add a real estate sector was based on extensive comments from investors and analysts as well as in-depth analysis and discussions between S&P Dow Jones Indices and MSCI.”
Of course, any change of this magnitude creates anxiety. “Unanticipated consequences are that people that are looking at the current financial index [are seeing] those returns have been enhanced by real estate,” noted Alexander Goldfarb, managing director and senior REIT analyst at Sandler O’Neill. “REITs will come out of financials, so the performance of the financial index can lose what had been a strong tailwind.”