REITs Are Coming of Age
On Aug. 31, major market indices will no longer bundle REITs inside of "financials" as an industry classification. Instead, they will reside in a new category called, surprise, surprise, "real estate."
The change, which expands the ranks of S&P Dow Jones Indices and MSCI Inc.’s stock classifications to eleven, is more than cosmetic. Having a home of their own means that REITs will see a flurry of fresh investor attention. In particular, money managers who have to reorder their portfolios to make sure they adequately reflect the make-up of certain indices their funds track are likely to embrace them as well.
Real estate stocks and financial stocks have behaved differently, historically, so they've made for awkward bedfellows. REITs, which make up the majority of the S&P 500’s real estate sector, for example, secure their earnings from rent collection and pay out their taxable income as investor dividends. Financial stocks trade more on interest margins and have lower dividend yields.
Real estate was barely present on the S&P 500 as recently as 15 years ago. It now represents about 3 percent of that index's value (as measured by the total market cap of its constituents).
Greater visibility for REITs in the S&P 500 hasn’t always translated to greater representation in the holdings of mutual funds and exchange-traded funds. According to data from research and investment firm Morningstar, actively managed mutual funds are more than 50 percent underweight for REITs, as measured across all asset classes.
Part of the problem has been REITs' close proximity to financial stocks in their shared industrial sector. Fund managers currently can opt for whatever mix of banks, insurance companies or REITs that they choose to make their portfolios representative of financial industry benchmarks.
But once real estate goes off on its own in August, fund managers are more likely to try to match the real estate weighting in their portfolio to a generic, 3 percent REIT benchmark that large-cap funds target. REITs are even more underweighted in small-cap and mid-cap funds, so managers also have more representative ground to make up for there.
Which REITs will stand to benefit most from the new taxonomy?
This past year, some of the best-performing REITs have been data, tower and apartment REITs. The chart above shows that the performance of many REIT types has been better than the stock market overall.
“My gut says the top 20 guys (those that are in the S&P 500) may see the most inflows,” says David Auerbach, an institutional REIT trader at Esposito Securities and author of a daily REIT newsletter. “I think you’ll have some that lean on the biggest names and others that look for pockets of opportunity in the sub sectors.”
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