Real estate equities to become a class of their own

Real estate equities are soon to be elevated to a dedicated industry class. What impact will the reclassification have on the sector? 

22nd August 2016

Continue to the other two articles in this edition of the Global Outlook...

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Real estate equities¹ are being elevated to a dedicated industry class, why is this significant?
On September 1st, 2016, real estate equities will be elevated to a class of their own and will become the eleventh sector under the global industry classification standards (GICS)² for equities, the first new sector since their introduction in 1999. The elevation reflects an appreciation of the sector’s special attributes by index providers and its recognition as a distinct asset class with an increasing role in global equity markets and portfolio diversification. Real estate has been historically classified as a sub-group of financials, along with banks, insurance companies, and asset managers, despite its distinct operating characteristics and performance drivers. As a standalone sector, real estate will represent around 5% of the global equities universe.
What impact will the reclassification have on the sector?
Improved awareness: The reclassification is likely to bring real estate into focus for international investors and highlight the attributes of a sector that has been amongst the top performing asset classes over the last 20 years. Separating real estate from financials will improve sector performance measurement and attribution and could result in increased attention from investors promoting a debate as to the appropriate allocation to the sector.
Increased fund flows: Real estate has historically been underweight in all-sector equity fund (by as much as 50% of their respective benchmarks), especially in the US, UK and Continental Europe. With real estate as part of financials this underweight bias has not always been obvious. Capital flows into real estate equities are expected to increase following the reclassification, with estimates reaching $100 billion³. Although possible we do not expect to see a sudden inflow into the sector but we should see an increased interest in real estate equities that brings more understanding of its special characteristics and valuation metrics, leading to increased investment over time.
Reduced volatility: Listed real estate has historically been more volatile than the underlying asset class partly due to the effects of leverage but also due to equity market influences unrelated to the sector. The financials sector has historically been one of the most volatile equity sectors. Over time, the separation of real estate from the financials sector may reduce trading linkages between real estate stocks and other financial companies such as banks and insurance companies, in that way removing a potential source of volatility.
Why should investors take a closer look at listed real estate?
Listed real estate equities can provide easy and efficient access to the global real estate markets and have historically provided attractive total returns of circa 9% p.a. over the last 20 years, exhibited relatively low correlation with bonds (0.48) and general equities (0.31) over the same period, and today offer a 3.9% dividend yield. The listed real estate universe is geographically well diversified, providing access to the underlying real estate markets in all continents. Sector diversification is also possible in most markets, especially in the US, where sector specialist REITs represent the traditional sectors like office, retail, residential and industrial but also alternative niche sectors like healthcare, student housing and self-storage. Given the cyclicality of the economy and the links of real estate to it, a long/short strategy may be the most effective way for investors to reduce volatility and achieve absolute returns at any point in the cycle. The search for assets that provide the potential for growing income and capital appreciation will continue to drive interest in listed real estate, which will only intensify as real estate gains a higher profile with its elevation to a distinct industry sector.

1. Includes real estate investment trusts (REITs) and real estate management and development companies (REOCs), excludes Mortgage REITs.
2. GICS is an industry taxonomy for equities developed in 1999 by MSCI and Standard & Poor’s (S&P) and it currently consists of ten industry sectors that break into 24 industry groups and many further sub-groups.
3. As estimated by JP Morgan Research.

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