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New S&P 500 asset class for real estate

Editor’s Note: The Inside Track is a recurring column written by a local business professional. Authors of these columns aim to provide you with their own perspective on a current trend or development within their industry, getting you on The Inside Track.

The Global Industry Classification Standard (GICS) was created in 1999 by Standard & Poor’s (S&P) to give investors a consistent framework for categorizing stocks, organized around ten primary sectors categories. Since that time, these sectors have been the global standard for slicing up the market to analyze performance trends, develop portfolio strategies and create investment products. On September 1 of this year, Real Estate became the first expansion since the GICS was created in order to separate equity Real Estate Investment Trusts (REITs), real estate management and real estate development companies from their former home as part of the broader category of “Financials.”

The decision to elevate Real Estate to the eleventh sector category arguably represents the most important index change since GICS was create 17 years ago, and the most important one for REITs since their admission to the S&P 500 in 2001.

Adding an eleventh GICS sector for Real Estate does not change real estate’s weighting in the S&P broad-market indexes. The affected constituents are simply reclassified from Financial to Real Estate. The 28 real estate stocks in the S&P 500 constituted 2.9 percent of the index. Now making Real Estate one of the smaller sectors, similar to Utilities, Telecoms and Materials, this new Real Estate sector, however small, does have the third highest yield, which could attract the attention of income-focused investors.

The GICS realignment acknowledges that Real Estate is fundamentally different than other business and that it belongs in a well-diversified portfolio. This change gives confidence that REITs have the staying power and return potential to support their own category.

The U.S. equity REIT market has grown since 1990 from $8 billion to almost $900 billion in total market capitalization, while global Real Estate securities are now worth $2 trillion. By pulling Real Estate out of the shadows of the financial sector and making it more transparent, I believe this new realignment will drive greater awareness of this asset class.

In our firm we typically find investors being significantly under weighted in real estate in their retirement assets accounts, whether ones’ 401-k or other non-qualified long-term assets. I also believe that this separation of real estate from Financials may encourage more investors to add real estate as an opportunity to further diversify their retirement holdings. This broader ownership may potentially lower their overall volatility as investors make greater distinctions between real estate and other businesses.

In conclusion, this new Real Estate GICS sector will direct more investor awareness to investment opportunities in REITs. This non-guaranteed investment option offers inflation hedging characteristics that potentially provide low historical correlations with broad stock and bond markets. Investors would be well served to review what part Real Estate plays in the overall allocation of their long-term investment holdings.

Mark S. Martel, CFP®, is a local investment advisor representative and offers securities and advisory services through KMS Financial Services, Inc. He can be reached at 360.694.9940.

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