Listed real-estate companies have finally been given their own sector classification within the Global Industry Classification Standard (GICS), the industry breakdown used by index providers MSCI and S&P. This is the first time a new sector has been added since the system was launched in 1999, and underlines the prominence of real estate as an investment.
The reclassification, which takes effect at the next index rebalancing on 16 September, brings equity real-estate investment trusts (Reits), as well as property management and development companies, out from under the wider umbrella of the financials sector. Mortgage Reits (which buy real-estate debt) will remain in the financials sector, given that they are more of a financial than a real-estate security.
At the moment, fund managers can choose any combination of banks, insurance companies or Reits in order to fulfil their exposure to the financials sector and stay in line with benchmark indices. Now that real estate has its own sector, it is likely that managers will deliberately buy into property investments to reflect the make up of the new index. The European Public Real Estate Association has estimated that Europe-listed real estate could attract €75bn in additional investment flows as a result of the reclassification.
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There are reasons why some fund managers have chosen to underweight Reits in the past, says Stephen Foley in the Financial Times, and these will not disappear upon reclassification.
Firstly, Reits are required to pay out 90% of their profit in dividends, meaning they often return to the market to raise more equity capital. This tendency towards dilution puts off some active managers.
Secondly, many Reits are not traded as often as other equities, meaning they can be less of a liquid investment. Finally, Foley also points out that many institutional investors already have exposure to physical real estate and do not wish to duplicate this exposure.
The most likely outcome of the change is that Reits will experience a short-term boost, but it's not a reason to expect them to outperform over the long term. So investors shouldn't be putting money into them purely on the basis of the reclassification. That said, while UK-listed Reits have underperformed their European and US counterparts over the past few years, the sector seems to be recovering from its post-Brexit fall in July, while yields remain in line with their average over the last ten years, so Reits should still make a sensible addition to a diversified portfolio.
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