Once a niche investment, real estate investment trusts (REITs) have seen enormous growth in recent years, and the flow of money into the sector may be about to accelerate.

Earlier this month, global equity indices were reconfigured. Since it was established by MSCI and Standard & Poors in 1999, the Global Industry Classification Standard (GICS) has consisted of 10 sectors. Now there are 11. Real estate, previously classified as part of the financial sector, has been recognised as a standalone sector for the first time.

As S&P index committee chairman David Blitzer said in a June blog post, this is more than a case of “rearranging the place cards on the table”; it is likely to result in increased interest in REITs, quoted companies that own or manage property.

Institutional investors around the world use the GICS system to gauge their asset allocations. The European Public Real Estate Association (EPRA) has estimated the change could drive up to €75 billion into European listed property companies. Currently, approximately half of European institutional property investors do not invest in listed property firms, it says, while the remainder allocate an average of approximately 2.5 per cent.

This reluctance, it suggests, is best explained by concern among institutional investors regarding the volatility of public markets, a concern that may be ameliorated by splitting REITs from the more volatile financial sector.

Underweight

The association promotes the European listed property industry, and sceptics might note that investors wary about exposure to volatile banking shares already have access to exchange-traded funds that focus solely on REITs. Still, others have also argued that the new sectoral changes will catalyse interest in listed property.

Many active fund managers have chosen to stick to conventional stocks with which they are familiar rather than venturing into the world of REITs, which come with their own valuation metrics and tax considerations. According to Goldman Sachs, almost 40 per cent of US large-cap managed funds do not own any REITs, while those that do tend to hold an underweight position. Last year, JPMorgan estimated this underweight position could result in some $100 billion in inflows.

Doubtless, some of that money has already made its way into REITs. Changes to the GICS system were first announced last year, so active managers have had plenty time to rotate into the industry. However, recent analysis from Morningstar suggests managed funds remain more than 50 per cent underweight for REITs.

The creation of a new real estate sector means many active managers, who tend to be wary about owning portfolios that differ significantly from benchmark indices, will come under pressure to justify their lack of exposure.

Becoming the 11th GICS sector gives listed real estate additional prestige and prominence. S&P and MSCI, as Financial Times columnist John Authors noted recently, “have done the REITs industry a big favour”.

Becoming the 11th GICS sector gives listed real estate additional prestige and prominence. S&P and MSCI, as ‘Financial Times’ columnist John Authers noted recently, “have done the Reits industry a big favour”. Photograph: iStockphoto

Growing importance

The move recognises the growing importance of listed property firms in global markets. Although first established in the 1960s, there were no REITs in the S&P 500 as recently as 2001. Today, there are 28 REITs and property management and development companies in the index.

Worth more than $600 billion, their total market capitalisation accounts for approximately 3 per cent of the S&P 500 – more than that of the telecom and materials sectors and comparable to the utilities sector. REITs have increasingly gained traction outside of the US, including in Ireland, where three firms – Green Property Reit, Hibernia Reit and Irish Residential Properties Reit (Ires) – have floated on the stock market since 2013.

For investors, REITs are attractive on a number of levels. Offering low-cost, diversified access to property, they are more liquid than open-ended property funds;

ABOUT THE AUTHOR: