A change is coming at the end of the month in the way stock indexes are classified. Real estate, now part of the broader financials category, will go out on its own.
But before you yawn and say that the change seems akin to moving the deck chairs around on a ship, consider this: It could, analysts say, have a wide-ranging impact on what individual investors own in their portfolios. That’s because an increasing number of people are investing in index funds, and those funds track the various categories of investments.
First, a bit of background. In 1999, Standard & Poor’s and MSCI, two providers of indexes, joined forces to create 10 categories of investments that they called the Global Industry Classification Standard. The standard has allowed investors to compare the performances of companies within the same sector and analyze why their stock prices are moving as they are. The classification also forms the basis for the MSCI and S.&P. indexes.
Since its inception, the financial sector has included banks, real estate,insurance companies and diversified financial groups. But in 2014, as part of regular reviews of the indexes, the two firms decided to create an 11th sector, real estate. (They also added a subindustry group for copper.)
David Blitzer, managing director and chairman of the index committee at Standard & Poor’s, said the decision came after lengthy debate on how real estate’s role in investing had changed since the standard was created.
“Think back to 1999 or 2000,” he said. “No one really talked about investing in real estate. We were trying to recover from the tech boom and bust.”
But in the years since, the market capitalization of real estate investment trusts, or REITs, which allow investors to buy stock in companies that own real estate, jumped to 900 billion in 2014 from $124 billion in 1999.
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Mr. Blitzer said the teams at S.&P. and MSCI agreed that it was time to give real estate its own sector. The changes will go into effect on Aug. 31 for MSCI-managed indexes and on Sept. 16 for S.&P.’s funds.
The question of what the change means in the short and long term for investors has been the subject of much debate. And that has led investors to think about the value of real estate investing more broadly.
Mr. Blitzer said he was confident that the new category would make investors more aware of the sector. “It’s going to raise the prominence of anything related to real estate,” he said. “Whether it makes prices of REITs go up or down, it’s not clear to me. They will get some more attention. That’s a plus for an investor who follows REITs.”
At its most basic, the change means people who index their investments will have a more accurate way to measure the performance of individual sectors. David B. Mazza, head of exchange-traded fund research at State Street Global Advisors, said separating real estate will make the asset class seem less forbidding to individual investors.
“Most investors already have some dedicated real estate exposure, as in a REIT fund or an alternatives bucket,” he said. “What this does is make real estate less of an alternative and more of a consumer staple.”
Kim D. Arthur, chief executive of Main Management in San Francisco, said just having real estate separate from the broader financial category is going to show investors how much better real estate has performed than other sectors within that category.
“REITs since 2005 are up 160 percent,” Mr. Arthur said. “The banks in that group are down 30 percent. People say the financials have underperformed, but it hasn’t been that bad. That’s because it’s been masked by REITs.”
Recent performance aside, he noted that REITs and banks tend to react differently to interest rate movements. When rates are low, as they have been, REITs perform better because their borrowing costs go down while their rents stay fixed. When rates go up, banks do better since they can charge more to lend money.
Given this, Mr. Arthur said his firm is planning to sell its holdings in real estate when they get separated from the broader financial services exchange-traded fund and buy more of a financials exchange-traded fund, despite the sector’s poor run. He is betting that interest rates are more likely to rise than to continue at low levels.
David Lukes, chief executive of Equity One, a REIT that owns, develops and operates shopping centers, said the additional attention would be good for a REIT like his. But he said he also believed that it would benefit investors because of the added scrutiny the sector will receive. “I think we’ll see even more focus on corporate governance, sustainability and dividend security,” he said.
Seeing real estate as a stand-alone sector in an index could also drive more money to REITs.
Matt Neska, domestic equity specialist at the investment banking and asset management firm William Blair in Chicago, said professional investors had underweighted REITs to trim their overall exposure to the financial sector.
He pointed to the Russell 2000 Value index, where financials accounted for about 45 percent of the stocks. Now, with the new category, it will be 30 percent financials and 14 percent real estate. “A lot of your small and midcap value managers had about a 10 percentage point underweight to this new real estate sector,” he said. “Given that, they have to close that gap or answer questions.”
He added, “It’s hard to quantify just how much capital will go into this space, but it could be a tailwind.”
Others, though, argue that the REIT sector has already run up in value and that it is not only fully valued but could collapse if interest rates go up.
“I’d be surprised to see what some people have talked about, that there will be much more money going in,” said Jeanette Garretty, managing director at Robertson Stephens in San Francisco. “It may be a situation of money moving away from the banking sector and following the REITs, so it looks like more money going to REITs.”
Mr. Mazza of State Street said the data showed that this is already happening. From the beginning of the year to the end of July, $6.1 billion has left financial exchange-traded funds and $6.6 billion has gone into real estate ones.
New money going into REITs, Ms. Garretty said, could come from less sophisticated investors. “For most professional managers, I’d be surprised if it’s going to change their behavior much,” she said. “But with the ongoing growth of index investing, it may lead to more individuals running their own portfolios putting money into REITs because there’s a real estate index.”
And that could be a problem if REITs are as overvalued as some analysts believe. “They’re certainly not an underowned area, but there is demand for them,” Mr. Mazza said. “If we see the market pricing in an interest rate hike, we might see a reversal.”
Brett Carson, director of research at Carson Wealth Management in Omaha, takes a dimmer view still. He sees the whole REIT sector as overvalued.
“It’s a bond proxy like utilities, consumer staples and telecom, and that’s a crowded place right now,” he said. “Valuations are stretched. Maybe the fundamentals have peaked or have potentially rolled over. There are some indications, particularly within the commercial property market, that things are beginning to erode.”
Whether REITs are about to crash or ascend to new heights, one thing is certain: The new category will help investors track exactly how their real estate investments are doing.
[Source:-The New Yourk Times]
