Regardless of what happens to their stock prices, REITs are set to break out come September.
Real Estate will be elevated to a Level 1 Global Industry Classification Standard sector in MSCI, S&P and Dow Jones indices next month. That means equity REITs and other real estate companies will no longer be part of the financial sector in this first new-sector elevation since the GICS was established in 1999.
This change reflects both the size and importance of listed real estate equities, while it underscores that listed equity REITs are an important component of the real estate asset class, says Wilson Magee, portfolio manager for the Franklin Real Estate Securities Fund (FREEX) .
Magee adds that the move also validates "the long-term acceptance of equity REITs by all investors" and the strong performance and risk characteristics likely to support increasing demand for real estate stocks as well as long-term capital formation and growth for U.S. REITs.
Post changes, index weightings for real estate will be similar to those of utilities in S&P 500 and MSCI World. Financial sector weights will decline by about 20%, according to Magee, with financials in the S&P 500 declining from 15.7% to 12.5%.
U.S. REITs have higher dividend yields than financials and those yields have proven to be not only stable but growing over the past five years, according to Magee. Also, U.S. REITs have far less leverage than most financial companies and are typically less sensitive to changes in interest rates.
From a performance perspective, U.S. REITs have produced better returns and much better risk-adjusted returns than financials over the trailing 3-, 5- and 10-year periods. The iShares U.S. Real Estate ETF (IYR) is up a hefty 9.5% thus far in 2016, more than three percentage points higher than the S&P 500.
First Industrial (FR) is one of Magee's top REIT picks, as it will benefit from healthy industrial markets and increasing e-commerce. Magee is also bullish on Vereit (VER) , which he calls a "transformation story for higher risk investors."
"History suggests that REITs offer appealing performance, risk and diversification characteristics that, given the new sector status, will force investors to consider U.S. REITs when building any well-diversified portfolio," says Magee.