What you need to now about REIT classiciations
Exactly how REIT Classification Benefits Preferred Securities
Excluding traditional financial companies does not mean excluding the attractive income-producing Investment Trusts (REITs) segment. 1 In fact, REITs, as well as other exchange-listed real estate companies, will be removed from the Global Industry Classification Standard (GICS)Financial records sector and placed in the new Real Estate sector at the conclusion of August. 3 We believe that this separate sector classification indicates REITs have grown to be a more robust segment of the market. One positive impact might be increased institutional demand for REITs, as investment managers tend to maintain pace with their benchmarks’ sector weightings.
Preferred securities have been a haven for some income investors dealing with a dearth of good income options in the present low interest rate environment. Investors who target preferred securities can perform so without overweighting their financials sector exposure and without compromising yield potential.
Market Realist – The creation of a new property sector under GICS classification
In its first addition since the introduction from the GICS structure in 1999, S&P Dow Jones Indices and MSCI (MSCI) decided to shift stock exchange-listed equity REITs and other listed property companies from the financial sector (XLF) to a brand new real estate sector. Under this change, the REITs industry has been renamed “equity REITs” and excludes mortgage REITs (MORT), which remain underneath the financial sector.
The GICS classification system is a considered a worldwide benchmark, so it has an immense impact on performance evaluation and portfolio allocation strategies among investment managers. Classifying REITs like a GICS sector authenticates the importance of real estate and equity REITs like a prominent asset class that can benefit both investors and property companies.
As of August 31, the financial sector has the 2nd heaviest weight of 17. 3% in the S&P Composite 1500 Catalog, a broad-based index covering approximately 90% of US market capitalization. Following reclassification, real estate is likely to have a weight in between 3. 5% and 4. 5% in the index. Plus, although the exact list of constituents of the new real estate field is unknown, it’s estimated that about 95% of the companies is going to be listed as equity REITs.
In this world of low development and low rates, preferreds (PFF) could offer alternative investment choices for investors seeking higher relative yield and portfolio security. In the whole universe of preferred securities, ex-financial preferreds (PFXF) could lower huge concentration risk and supply diversification benefits to investors.
Effects of the Upcoming GICS Classification for that REIT Industry
Since last year, Aug. 31, 2016, has been circled about the calendars of REIT professionals and dedicated REIT investors. However, what many think about the biggest development to hit the sector in 15 years might have a greater impact on those investors that previously overlooked REITs compared to anyone. After the market closes on that date, stock exchange-listed Equity REITs along with other listed real estate companies will be elevated to a new Property Sector in the closely watched Global Industry Classification Standard (GICS), which makes it the 11th Headline-level Sector under GICS.
GICS serves as the actual de facto classification system for equities worldwide, providing an organizational framework for from performance analysis to product development. The move, which pulls listed Equity REITs along with other real estate companies from their longtime home buried in the actual Financials Sector, might sound routine and wonky to the uninitiated, however it is far from it. This is the first time because the launch of GICS in 1999 that a new Headline Sector is going to be added. It shows just how prominent the real estate as well as, in particular, the listed Equity REIT space – praised because of its handsome dividends, seasoned leadership, sound returns and diversification benefits – have grown to be.
Consider this a real estate classification revolution. Although the exact listing of constituents of the new Real Estate Sector has not however been announced, guidance provided so far suggests that about 95 percent from the companies will be listed Equity REITs, showing the sector’s power. Mirroring a similar reclassification move made to the North United states Industry Classification System in 2007, this latest development is already fueling increased discussion concerning the real estate asset class that includes trillions of dollars’ really worth of holdings nationwide.
Simply, listed Equity REITs and real estate companies won’t be a niche, but rather representative of the distinct property asset class. It is a “momentous event for the business, ” says Michael Knott, director of U. S. REIT investigation for Green Street Advisors, a real estate research firm.
“It is really a proper recognition that the public real estate arena is large enough and distinguished enough from Financials to become staked to its own Sector, ” Knott adds.
Indeed, this move “raises the prominence of property, ” says David Blitzer, who worked on the change as managing director and chairman from the Index Committee at S&P Dow Jones Indices, which jointly runs GICS with MSCI Inc.
Immediate Effects
The GICS promotion is similar to the decision in 2001 to include REITs in the S&P indices. REIT supporters cheered when Equity Office Properties Trust, the biggest U. S. Equity REIT at the time, became the first REIT contained in the S&P 500 Index, widely considered the most important benchmark for that largest American corporations.
In the last quarter century, the complete equity market cap of exchange-listed U. S. Equity REITs offers skyrocketed from $9 billion to $900 billion, and as of earlier this season, the S&P 500 included 26 REITs. The S&P indexes in general include roughly 90 REITs now.
The effects of the GICS promotion ought to be felt even quicker around the REIT industry, according to Erina Grupe, NAREIT’s executive vice president for research and investor outreach. “I think it’s reasonable to expect that… a few of these effects on how REITs trade and perform should become apparent next few years, ” he says.
Just what will those results be? Industry observers consistently cite a few.
Validation
In a feeling, the process of achieving a Headline Sector proved that the REIT approach to investment is enduring and solid.
The performance of the industry throughout the financial crisis paved the way for the GICS decision; REITs survived the one-two punch that took down banks and left an incredible number of square feet of housing in foreclosure.
“The Great Recession was an excellent test, and a lot of financial products didn’t pass which test, ” says Steven R. Brown, senior vice president as well as portfolio manager for American Century Investments. REIT stocks “sold away, but they didn’t implode, and they bounced back and individuals saw the long-term characteristics. ”
The strong performance following the actual global financial meltdown, as well as numerous countries adopting REITs, earned the area a look from S&P Dow Jones Indices and MSCI.
“We decided it had been time to seriously discuss real estate, ” Blitzer recalls.
Those deliberations included a gathering with a NAREIT delegation championing the change. It included Mike Zell, chairman of Equity Group Investments; David J. Neithercut, Collateral Residential’s (NYSE: EQR) president and CEO; Steve Wechsler, NAREIT’s leader and CEO; Mary Hogan-Preusse, managing director and co-head of Americas Property for APG Asset Management U. S.; and NAREIT’s Grupe.
Following a evaluation period, the answer was straightforward, according to Blitzer: REITs are “clearly considered quite legitimate and here to remain. ”
Increased Visibility
A dedicated GICS Real Estate Sector implies that Equity REITs should receive more attention from institutional investors, person investors and financial advisors, so look for a more diversified number of owners. This “could create a greater level of institutional investors within REITs as generalist investors who had a zero percent weight within the space” reconsider that decision, Brown says.
Some of the elevated visibility could come as more investment plans embrace REITs. Although 401(k) plans already offer REIT funds as a choice for “alternatives” selections, this increased visibility could drive greater adoption as more plan “sponsors seek to supply the potential diversification benefits of real estate for stock as well as bond portfolios, ” according to real estate investment firm Cohen & Steers, that has been an active investor in real estate securities for 3 decades.
Furthermore, the already populated pool of analysts covering detailed Equity REITs could grow. And while the media’s interest in listed Equity REITs has gradually acquired over time, many mainstream publications will likely boost their protection – and, potentially, criticism – of the space.
Thomas Bohjalian, the Cohen & Steers executive vice president and portfolio manager, also shows that more countries could adopt REIT-like legislation, while more private companies could choose to go public or merge into existing listed Equity REITs.
A Better Understanding of REIT-Based Investment
Although REITs in many ways have stripped away the connotations to be a niche investment, some generalist investors still struggle to grasp the initial characteristics of their
operations and performance. A Headline-level Real Estate Sector will probably breed better understanding, with less confusion surrounding many industry-specific terms for example “funds from operations” and “net asset value. ”
Other typical misconceptions, including the notion that REITs are a proxy for that housing market, could also be dispelled, according to Cohen & Steers.
As investors of stripes grow more familiar with REITs, that should encourage investment decisions depending on business fundamentals. Investors may be less inclined to use REITs because they do financial companies to express their views on interest prices, a welcome fact after recent fears weighed on the whole sector. Similarly, a better understanding of REITs could lead to closer focus on the differentiated property sectors, allowing active and thoughtful management in order to shine, according to Cohen & Steers.
Longer-Term Implications
Over period, the changes could be more far reaching.
As an instance, NAREIT and others maintain that Equity REIT stocks may experience lower volatility because of increased liquidity and the separation from the Financials Sector. Having a larger and more diverse investor base, the reclassification may also help further moderate the severity of housing market cycles, with attendant benefits for the broader economy, Grupe stated.
The distinction and visibility of real estate investment also will probably fuel the creation of new investment products, such as active and passive mutual funds and exchange-traded funds centered on the new Real Estate Sector. Advisors and managers will convey more fund options to recommend to clients, which could encourage and facilitate positive capital flows into listed property equities, Grupe said. Indeed, in late 2015, State Street Global Advisors announced the launch from the new
Real Estate Select Sector SPDR Fund, an exchange-traded fund to assist investors make specific allocations to the real estate asset course within asset allocation strategies.
Perhaps most importantly, those under-allocated towards the real estate asset class could have some explaining to perform. Grupe predicts that investors will begin asking more questions about their contact with REITs.
“Those conversations probably seldom take place, ” he states. “That will likely change, and that’s what’s important for just about all concerned. ”
The amount of subsequent investment could be significant, with estimates ranging from $30 billion to $100 billion in new capital entering the industry, as equity funds that have been significantly underweight in property look to achieve a market-neutral position. While Bohjalian doesn’t anticipate generalists to suddenly incorporate decades of learned behavior, “with the actual added transparency in sector performance, managers may want to think about the potential consequences of being underweight in an asset class which has outperformed the S&P 500 over the trailing 10-, 20- as well as 30-year periods, as well as in [seven] of the previous 10 calendar years. ”
GICS = Snapshot of Business
Set up in 1999, GICS is a four-tiered classification system for listed equities worldwide that is a global standard. It provides a structure for investors, experts and economists to consistently identify and analyze investment performance as well as economic activity, as well as to develop investment policies, items and research.
What is performing better – Financials or Property? GICS provides a quick and easy comparison.
The classification includes four amounts of analysis ranging from the most general Sector to the the majority of specific Sub-Industry. Not surprisingly, Information Technology is the largest field, followed by Financials and Health Care.
Annual reviews of GICS help ensure that classifications remain accurate and current as the global business landscape changes, though huge changes stay relatively uncommon. Under the new classification structure, listed Equity REITs will be shifted to a new Industry level classification named Equity Investment Trusts. The new Real Estate Sector will also include a brand new Industry level classification named Real Estate Management & Development to contain listed property companies other than listed Equity REITs.
Mortgage REITs will remain in the Financials Sector under newly created Industry and Sub-Industry classifications named Mortgage Investment Trusts. The new Equity REITs Industry classification will also consist of Sub-Industries for office REITs, diversified REITs and other property categories, which will allow for easy performance comparisons across different home types.
The changes will be implemented by MSCI and S&P Dow Jones Indices included in their annual index rebalancing on Sept. 16, 2016. (A summary of specific companies affected by the announced changes is expected absolutely no later than July 1, 2016. )