For many years, key market indices have lumped real estate securities in with banks and insurance companies in a broad Financials category, despite significant structural differences. However, on September 1, 2016, this will change, as S&P Dow Jones and MSCI introduce, for the first time since the Global Industry Classification Standard (GICS)SM sectors were created in 1999, a new, eleventh sector for real estate, consisting of equity real estate investment trusts (REITs) and real estate management and development companies. Mortgage REITs, which are involved in real estate financing, will remain in the traditional Financials sector. (FTSE’s indices already maintain a standalone REITs sector.)
GICS Real Estate Sector Changes
|
Current GICS Sectors |
New GICS Sectors |
|
Energy |
Energy |
|
Materials |
Materials |
|
Industrials |
Industrials |
|
Consumer Discretionary |
Consumer Discretionary |
|
Consumer Staples |
Consumer Staples |
|
Health Care |
Health Care |
|
Financials · REITs · Real Estate Management & Development |
Financials · Mortgage REITs |
|
Information Technology |
Information Technology |
|
Telecom Services |
Telecom Services |
|
Utilities |
Utilities |
|
Real Estate · Equity REITs · Real Estate Management & Development |
Source: MSCI and Standard & Poor’s.
In our view, the addition of the Real Estate GICS sector is a very positive development for real estate securities, for three reasons:
- Better awareness of the asset class. Equity REITs will be the ninth-largest out of 11 GICS categories, therefore increasing the awareness of this distinct asset class. Real estate securities offer higher yields than Financials and provide the potential for capital appreciation based upon the strength of the underlying fundamentals for commercial real estate. However, these attributes have often been obscured by their inclusion in the Financials sector. Separating them out will allow for more ready analysis of the real estate asset class and could generally lift the profile of these securities.
- Reduced volatility and correlations. Equity REITs have at times been buffeted by rapid shifts in sentiment as investors have bought and sold Financials ETFs in reaction to global events. As a standalone sector, real estate securities will more likely be judged by their own unique and sometimes highly local fundamentals. This could encourage smoother trading for the group overall and could also translate into more varying performance amongthe companies within the REIT sector, as their specific characteristics become more apparent.
- Increased demand. We believe that many investors are underweight the REIT asset class. For example, U.S. equity mutual funds hold only about 2.3% of assets in REITs, but the new benchmark weighting for these funds will be around 4.4%, according to calculations of real asset manager Capital Innovations, LLC.1As such, we believe many benchmark-sensitive investors that find themselves under-allocated to real estate are likely to make up this shortfall, which would increase demand for the asset class in the period before and shortly after the September 1 reclassification.
Recognition in a Complex Environment
The change comes at a turbulent time for capital markets, as investors weigh the impacts of monetary policy and prospects for global growth. Last year, the REIT sector saw significant ups and downs, but finished the year in positive territory in both the U.S. and globally. In 2016, returns have thus far been positive and higher than for the major equity indices.
In our view, the Federal Reserve is likely to continue tightening this year while other central banks maintain an easing posture; concerns about growth and generally cautious investors will likely cap longer-term rates. In the U.S., we believe the continued improvement of the economy and gradual pace of rate increases should be supportive of the commercial property market, while a more spotty European real estate market will highlight the need for careful security selection. In Asia, Japan and Australia are standouts given relatively stable property markets, but Hong Kong and Singapore markets appear more vulnerable given market sensitivity to U.S. rates and local economic concerns.
Fundamentals First
Overall, we believe that real estate companies with sustainable cash flow and dividend growth have the potential to perform well. Strong, flexible balance sheets that can withstand capital markets volatility will also be important.
In sum, we are very pleased with the upcoming creation of a dedicated Real Estate GICS sector, and while we also understand that the underlying fundaments we have mentioned are ultimately the key drivers in seeking returns in the real estate securities market, this eleventh GICS sector provides much-deserved recognition to an important asset class.
1 Source: Capital Innovations, LLC, Morningstar, FactSet, Bloomberg and J.P. Morgan Securities LLC, as of December 29, 2015. Capital Innovations, LLC estimates that there are roughly $5 trillion of assets held by ’40 Act equity mutual funds (index and actively managed) invested across the nine standard domestic style categories. This excludes sector funds, separate accounts, ETFs, pension funds, hedge funds and other vehicles. Of that number, $115 billion is held in REIT stocks, or 2.3% of the total. In comparison, Capital Innovations, LLC estimates that the funds’ average benchmark weighting in the new Real Estate sector will be approximately 4.4%.
The Global Industry Classification Standard (“GICS”) was developed by and is the exclusive property of MSCI and Standard & Poor’s. “Global Industry Classification Standard (GICS),” “GICS” and “GICS Direct” are service marks of MSCI and Standard & Poor’s.
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