S&P Dow Jones Indices Launching New Real Estate Sector

A new sector is being launched by S&P Dow Jones Indices after the markets close on September 16, moving the real estate companies from financials to their own segment. Lots of investments, particularly, ETFs focus on the area, and the compartmentalization the real estate category will allow investors to tap into the growth potential here more easily.

The 11th sector will be part of the Global Industry Classification Standard (GICS®) - Real Estate and will include REITs and real estate development companies. The transition is occurring because real estate companies consist of 3.1% of the S&P 500 and have a higher yield than financials, said David Blitzer, managing director and chairman of the index committee at New York-based S&P Dow Jones indices.

This change will lower the current yield for the financials sector and investors can expect changes to also occur regarding taxation since REITs are not tax-qualified securities. S&P DJI's indices will reflect the change after trading closes on September 16 and the first day of trading with the new sector will occur on September 19.

Since September 16 is the third Friday of the month, it is also triple witching day when equity options, equity futures and index options and futures contracts all expire, which means there will be a large amount of liquidity in the marketplace. Mortgage REITs will remain in the financials sector although none exist in the S&P 500 and only one, Capstead Mortgage Corporation Real Estate Trust (CMO), is in the S&P Small Cap 600.

Investors should also examine their portfolio's current exposure to real estate and consider rebalancing.

For the past five years, real estate has emerged as more attractive investment as various assets have made it easier for retail investors to include these companies in their portfolio, he said.

"Real estate development and REITs are where the focus really is," Blitzer said. "There is major interest from investors."

REITs have been a popular asset because they tend to pay higher dividends and are increasing in size, he said.

Moving REITs and real estate development companies into their own sector has been in the works for the past two years, giving institutional investors an opportunity to revise their software programs, Blitzer said.

"The time had come to break out real estate," he said. "This sector is a big chunk of investing and many ETFs and assets focus on it."

Investors were turned off by the real estate sector in the aftermath of the 1973-74 busts, although many REITs were created earlier in the decade, Blitzer said.

The sector slowly emerged again in the 1990s, but people were more interested in investing in the tech sector until the tech bubble occurred. When tech stocks collapsed, money poured back into REITs, he said.

"We review it on a regular basis because the world changes," Blitzer said. "Investing in 2016 is not the same as 1999. This element of the investing world has changed and has been adjusted to keep current."

As of September 2, 28 companies with a market value of more than $585 billion and represented almost 20% of the value of the financials sector in the S&P 500 will be removed to form the real estate sector. These companies include the following:

  • American Tower Corp (AMT)
  • Apartment Investment & Management (AIV)
  • AvalonBay Communities Inc (AVB)
  • Boston Properties Inc (BXP)
  • CBRE Group Inc. (CBG)
  • Crown Castle Intl Corp (CCI)
  • Digital Realty Trust (DLR)
  • Equinix Inc (EQIX)
  • Equity Residential (EQR)
  • Essex Property Trust (ESS)
  • Extra Space Storage Inc (EXR)
  • Federal Realty Invt Trust (FRT)
  • General Growth Properties Inc (GGP)
  • HCP Inc (HCP)
  • Host Hotels & Resorts Inc (HST)
  • Iron Mountain Inc (IRM)
  • Kimco Realty Corp (KIM)
  • Macerich Co (MAC)
  • ProLogis Inc. (PLD)
  • Public Storage (PSA)
  • Realty Income Corp (O)
  • Simon Property Group A (SPG)
  • SL Green Realty Corp (SLG)
  • UDR Inc. (UDR)
  • Ventas Inc.  (VTR)
  • Vornado Realty Trust (VNO)
  • Welltower Inc.  (HCN)
  • Weyerhaeuser Co.  (WY)

Since GICS was created in 1999, this is the first change to the existing sectors. This restructuring will generate short-term volatility, but also a far-reaching positive impact on the market, said K C Ma, a CFA and director of the Roland George investments program at Stetson University in Deland, Fla. This break up has been "partly prompted by the significant divergence in performances among the industries in the sector," he said. "For year to date, within the financial sector, the REITs have returned 18%, commercial banks -2% and insurance 5.3%, compared with the S&P 500 Index of 4.7%."

Creating a new sector is the right move since the two sectors are impacted by different economic metrics. Since the banking industry has been "under the cloud of the Fed's indecisive interest rate policy for years and the wait is not over," it has turned into one of the worst performing sectors in the S&P 500 since the 2008 financial crisis, said Ma.

The real estate sector has performed well with the Vanguard REIT ETF rebounding over 250% from its low of 2008.

"The breakup of the two distinctively different industries allows investors to 'surgically' separate the individual risk and return profiles," he said. "For portfolio managers who seek to achieve an optimal level of portfolio risk, they can create 'home-made diversification' by investing accordingly in the new real estate sector and financial sector ETFs, which they could not have done before. Investing in one big ETF is not the same as investing in half of two smaller ETFs."

Investors should expect significant market volatility in REIT-related stocks from the hedge fund arbitrage trades, Ma said. There will significant outflow and inflow of REIT stocks from the old S&P Financial Index funds to the new S&P Real Estate index funds.

"It is estimated that the volatility resulting from the arbitrage trades should be contained within days," he said. "It is estimated around $4 billion REIT stocks are at risk of changing hands, which is not an outrageous amount. In the long run, both the underwriters and the investors will enjoy the higher liquidity of the newly designed sectors and the ETFs."

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