Ed Fritsch (BSBA '81) rings the NYSE Closing Bell on Sept. 14, 2016. (Photo: NAREIT)

Movin’ on up: Real estate gets its own S&P 500 sector

Ed Fritsch (BSBA '81) rings the NYSE Closing Bell on Sept. 14, 2016. (Photo: NAREIT)

Ed Fritsch (BSBA ’81) rings the NYSE Closing Bell on Sept. 14, 2016. (Photo: NAREIT)

On September 14, 2016, the familiar sound of the NYSE Closing Bell was a clarion call to investors worldwide: real estate has arrived.

Edward J. Fritsch (BSBA ’81), chair of the National Association of Real Estate Investment Trusts (NAREIT), rang the closing bell that marked the introduction of real estate as the 11th headline sector under the Global Industry Classification Standard (GICS), which determines how equities are categorized in the S&P 500 and other indices. The addition of real estate – which had previously been lumped into the financials sector – marks the first change of its kind since the GICS was created in 1999. The new real estate sector is comprised of Real Estate Investment Trusts (REITs) and real estate development companies and accounts for approximately three percent of the S&P 500’s market capitalization.

While all of this may sound esoteric, the implications for real estate investment are significant. The move to distinguish real estate speaks to its permanence and viability as an asset class and raises its profile with investors of all sizes. It will require passive investors to reallocate their holdings to remain in line with underlying indices and, perhaps more importantly, may spur some active managers to buy REITs for the first time.

“It is commonly thought that before the change, real estate was underweighted in portfolios that were benchmarked to GICS-related indices,” says Jacob Sagi, associate professor of finance at UNC Kenan-Flagler. “Based on this thinking, as benchmarked portfolios adjust to the weightings from the new classification, the net impact will be an increase in capital flows into REITs.”

In addition to attracting new capital, real estate’s elevated status is likely to expand its coverage among research analysts and the media, which will further encourage the spread of the REIT structure around the globe.

The GICS reclassification is also likely to improve investor access to these assets through new products, such as sector-targeted Exchange Traded Funds (ETFs) and expanded real estate investment offerings on the part of pensions and retirement program administrators.

Enhanced access will enable investors to diversify their portfolios more easily and precisely than when real estate was part of the financials sector. Such a steadily growing base of investors is often thought to create a floor under asset prices, but not everyone agrees.

“The usual story about floors is that if we have passive investors who have to hold an asset to achieve their diversification requirement, prices are less likely to fall as investors flee overvalued assets,” says Bob Connolly, associate professor of finance. “I am skeptical about the floor notion in this [real estate] context.”

Given the historic nature of the new GICS classification, it is not surprising that consensus is hard to come by. Despite these varied perspectives, one thing is certain: real estate is movin’ on up.

By C.J. Overly (MBA ’17)