Real estate investment trusts (REITs) have gained so much momentum as a major force in real estate, they are being put in their own sector in an important investment classification tool and could be in for a capital boost from all the attention. Following market close on August 31, equity REITs were reclassified as their own index category of the Global Industry Classification Standard (GICS) instead of being paired with the greater finance sector. The change will take effect Sept. 16, to coincide with the S&P 500 annual rebalance of the indexes.
The breakout sector is the first change since the creation of GICS, which is a tiered, hierarchical industry classification standard developed by Standard & Poor and Modern Index Strategy Indexes (MSCI) in 1999. Publicly-listed companies are assigned a single GICS classification according to their principal business activity. GICS is used by thousands of market participants across all investment groups and plays a role in investment portfolio diversification.
By breaking out into a its own sector, it is likely that REITs like the Big 3—HCP Inc. (NYSE: HCP), Ventas Inc. (NYSE: VTR) and Welltower Inc. (NYSE: HCN)—will start getting more attention from investors as a mainstream asset class, potentially even becoming known as a core food group within investment portfolios.
Senior living REIT executives have been bullish on the sector breakout for some time, with expectations it will bring REITs into the mainstream.
“I think our sector will gain another boost in August after REITs claim our own category under the Global Industry Classification Standard (GICS),” Ventas CEO and Chairmen Debra Cafaro told SHN in July. “REITs will have more visibility and appeal to a larger group of investors; generalists will find Ventas very attractive because of the power of our aging demand and reliable growth and income we provide.”
What Does it Mean?
As this is the first breakout from the current 10 sectors within GICS, it is unclear exactly what impact the new designation will have. However, the change will surely bring new attention to REITs, which made their first presence on the S&P 500 in 2001.
“The sector gets more visibility,” Britton Costa, analyst with Fitch Ratings, told Senior Housing News. “Historically, REITs were part of financial institutions. The breakout is partly symbolic, showing that real estate is a unique sector. It is not financial. That changes the general perception that REITs should behave like financial institutions would.”
However, there could be a significant financial impact, some argue. With new market weight, investors and fund managers could throw as much as $100 billion into the new sector, Reuters reported.
“It’s an important recognition for the asset class and does bring in the potential for investors and greater focus on the investment type,” Michael Knott, director of U.S. REIT research at Green Street Advisors, told SHN. “I don’t know that it will be a dramatic impact on day one. It’s definitely an unknown.”
Investors who may have previously overlooked REITs or clumped them in with the greater financial sector may feel more inclined to hold a higher position in the asset class, which could boost overall interest and investment in the sector.
“We don’t have precedence for what this means. It will be net positive for REITs,” John Kim, analyst with BMO Capital Markets, told SHN. “More investors will be looking at REITs as a standalone sector. Before it was a component of financials, so it was easy for investors who utilize GICS to underweight or have a zero position in REITs. Now, to have that position is a little more glaring because it’s its own sector. The question is, what’s the magnitude of that positive move?”
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The other side of the breakout—on the greater financial sector—could actually have a larger impact, as REITs have been a driver of high dividends for investors over the last few years. After leaving the finance sector on the classification, it will likely see its yields drop.
When thinking about those numbers floating around, which range anywhere from $5 billion to $100 billion in additional investment stemming from the GICS breakout, the real impact is actually too uncertain to quantify. Others speculate that a boost to the new sector won’t likely be significant, at least in the short-term, and the long-term impact is still much harder to predict. Having been a part of the S&P 500 for some time, investors may already have the asset class on their radar.
“With REITs having been a part of the S&P 500 for a while, it’s not like investors haven’t heard of this asset class,” Knott said. “I would doubt it will be the type of environment where you’ll notice a big pop in REIT prices. … I think it’s incredibly difficult to predict.”
Others doubt that the breakout will have much immediate impact, surmising that some of the recent gains senior housing REITs have seen in their share prices could be in anticipation of the new sector. In other words, the boost may already be priced into REITs’ share prices, which have recovered after a large decline at the start of 2016.
“A lot of REITs have performed very well from a share perspective over the last three to four months,” Brad Thomas, editor of the monthly subscription-based newsletter Forbes Real Estate Investor, told SHN. “My sense is that you won’t see a drastic shift or price change. Some of that has already been priced in.”
At the same time, the long-term impact could be substantial, according to Thomas, who noted that the $100 billion speculation could be “realistic.” Market capitalization for U.S. equity REITs is close to $1 trillion, according to the National Association of Real Estate Investment Trusts (NAREIT).
“That’s about 10% of the overall market capitalization,” he said. “There could be 10% movement in capitalization, but it won’t be overnight.”
At this time, there are still more questions that remain, but it’s certain that REITs will get new recognition nonetheless.
“It’s a pretty big event when a sector gets its own classification,” Costa said. “The breakout does cause more visibility for REITs, but will others start looking at REITs? Does that bring new money investing in the space and does that help valuations overall? It’s probably too early to tell if there will really be an impact, but the symbolic side is pretty meaningful.”
Bottom line: REITs will net a win.
Written by Amy Baxter