Marketweek
How REITs’ new berth in GICS may impact
capital flows, conversions
By Tom Yeatts
The REIT universe’s expansion and growing influence
at home and abroad pushed MSCI and S&P Dow Jones
Indices to propose this week a major change to the
Global Industry Classification Standard, the influential
industry classification system used by many in investment
management.
For the first time since 1999, when the GICS system was
established, there will be an 11th sector, for real estate,
which will be broken out of financials and granted its own
berth.
MSCI and S&P, which jointly developed the GICS taxonomy,
have never added or “killed” a sector.
The move is both an affirmation of real estate’s significance
as a distinct asset class and a potentially unsettling wild
card, according to observers. It will firmly establish the
REIT set, putting more eyes on the space. But it will
also create some uncertainty, at least in the short term,
about capital flows into the space and between the REITs
themselves. REITs and telecommunications would be the
smallest sectors under the methodology (mortgage REITs
will remain in financials).
The increased scrutiny on real estate and on REITs, in
particular, might also have ramifications for the number
of new “nontraditional” REIT players, companies that
have migrated to the sector in search of liquidity and
tax “efficiency.” In an interview, David Blitzer, managing
director and chairman of the Index Committee with S&P
Dow Jones Indices, said the move could lead to a narrower
definition of real estate, potentially damaging the prospects
of companies looking to move into the space.
As of now, there is no guarantee the classification change
will be implemented. There will be a comment period this
winter, with a formal decision not expected until March.
If implementation goes forward, it will occur after market
close Aug. 31, 2016. Blitzer told SNL the odds that the
change will be implemented by the proposed date at “90%
plus.”
“A typical GICS change is much smaller, much less
dramatic, and is probably implemented with something
between six and 12 months lead time, depending on what
exactly it is and the way the calendar works,” he said. “But
this one clearly needs a whole lot of extra time.”
The long lead time is, in part, a concession to the
organizations that are committed to the existing 10-sector
structure. There are other technical considerations;
databases and analytical tools that use GICS will have to be
reprogrammed.
“A lot of people said ‘You can’t do this overnight.’ We
have to rewrite some databases, we have to restructure the
way we do some analyses,” Blitzer said. “We also have a
lot of exchange-traded-funds and other products that are
based on the existing 10 sectors, and we have to think this
through. And we recognize all that.”
Blitzer, who framed the break-out of real estate as the most
significant proposed change to-date to the GICS structure,
said S&P and MSCI had weighed the change for years.
The time had finally come. REITs in particular, he said,
have gained a “huge” amount of attention as tax-efficient
vehicles and dividend-yielding instruments. Roughly threequarters of participants in its most recent consultation
supported the move to separate out real estate from
financials, he said.
“We felt it was really the point — not just in the U.S., but
in markets around the world — it was time to separate
them out,” he said. “Now it seems like every time we sit
down and go through a global REIT index, we add three
more countries to the list of possible sources.”
Near term, the stakes of the reclassification of real estate
could be high. Morgan Stanley hosted a conference call
Nov. 12 to examine the potential impacts on the REIT
space, and Victor Morange, quantitative strategist at the
firm, said the reallocation process “could be very quick,”
assuming a “clean” split from financials.
Morange said further that some of the new nontraditional
REITs could well migrate back to their sectors of origin —
the tower companies back to telecommunications, and the
timber players back to materials and paper products, for
example. However, he noted that in the index committee
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meetings he has attended, there was broad support for
keeping data warehousing classified as a “true” REIT.
S&P’s Blitzer, notably, told SNL that this reverse migration,
among those that have already converted to REITs, would
be unlikely.
Morgan Stanley analyst Haendel St. Juste, in a Nov. 13
research note, pointed to clear long-term benefits for REITs
likely to come from the reclassification.
“To the extent that this increased acceptance of REITs
continues (and it should actually accelerate with the
implementation of a stand-alone GICS sector), it should
continue to be a positive for the sector,” he said.
On the call, St. Juste identified three vectors of thought
in his conversations this week with investors and others.
Bears think moving real estate out of financials will prompt
financially oriented mutual funds to sell REITs, while bulls
think the move will push nondedicated managers who are
“meaningfully under-weight” on REITs to allocate more
capital to them. And a third group thinks the classification
change will be a “wash,” with investors finally able to make
a direct call on REITs, positive or negative.
stocks specifically are at more or less risk in the proposed
realignment is a difficult question to answer — and rife
with uncertainty, especially without knowing the new
weightings,” St. Juste said. Large caps will have an edge
among “generalists” in the immediate aftermath. Small
caps may still present “liquidity challenges” for some.
Those REITs in between, he said on the call, may be the
real winners.
“I think in the long run, the real winners here might end
up being the mid-caps because they’ll likely benefit from
increased liquidity and access to a wider investor base who
might have only previously looked at large caps,” St. Juste
said.
Another question left unanswered on the call was the
extent to which the new classification will drive real estate
valuations even higher. St. Juste noted that implied cap
rates in the REIT space are now roughly two standard
deviations above the historical average.
“Maybe the added focus, attention, liquidity drives a nearterm re-rating, but, over the long term, perhaps valuations
revert back to more normalized levels,” he said. “It’s a
question we’ll all debate here.”
Which real estate stocks may benefit on a relative basis
remains a key question. “The exercise of identifying which
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