Real Estate to Become Its Own S&P 500 Sector

Moving real estate out of financials and into its own sector should increase its importance in investor portfolios

The world according to the Global Industry Classification Standard for stocks is changing, and investors need to understand the new world order.

It starts with the elevated importance of real estate. Growth has been so phenomenal that S&P Dow Jones Indices and MSCI, which developed and oversee the GICS, are moving real estate out of the financial sector space that it has historically occupied and creating a separate standalone sector for real estate, effective Sept. 19.

“The real estate sector will have more prominence,” explained David Blitzer, managing director and chairman of the index committee of S&P Dow Jones Indices, during an educational S&P webinar.

The new real estate sector will include 28 real estate development stocks and REITs and account for 3.5% of the weighting in the  S&P 500. As of June 30, 2016, the floating adjusted market cap was $588 billion. Mortgage Reits will remain a part of the financial sector.

“Being elevated to a separate sector itself is a significant event and it puts real estate on the map,” said David Mazza, managing director, head of ETF and Mutual Fund Research for State Street Global Advisors.

At the same time, the financial sector, which has included real estate stocks, will lose some of its importance.

Impact on the Financial Sector

Currently, financial stocks accounts for 16% of S&P 500 sector allocation, explained Mazza. Only Information technology is larger, at 20%. Once real estate is pulled from the financial sector, financials will fall to 13% of the S&P 500, becoming the third largest sector, behind healthcare.

In addition,  financials will lose one of its star performers, listed REITS, which have performed better than the broader financial index since 2001, said Paul Murphy, VP, product management, US equities for S&P. REITS had a more than 100% return over 11 years, due in large part to falling interest rates, according to Murphy.

But he cautioned that REITs do not enjoy the same tax benefits as financial capital gains, and therefore might be best used in deferred benefit accounts.

These changes will affect State Street’s  Financial Select Sector SPDR Fund (XLF), but Mazza is confident that XLF, which has been around since 1998 and has a daily volume of $1 billion, “will continue to have liquid exposure. “

He said State Street plans to declare a special dividend for XLF shareholders in the form of shares of the Real Estate Select Sector SPDR® Fund (XLRE). Payment date for the dividend will be on Sept. 22, after the change by S&P and rebalancing of XLF and creation of XLRE.

Not new to ETF investors

Michael Orzano, director of product management, global equity indices, S&P Dow Jones Indices, said that the new GIC real estate sector is not new to ETF investors. Real estate REITs have $50.3 billion in AUM and comprise the largest sector of ETFs, said Orzano.

The next largest sector is energy, with $43 billion in assets, followed by health care, with $36 billion, then tech ($29 billion) and financials ($27 billion). “The flows have been strong,” said Orzano.

He noted that the new S&P U.S. Reits index does not include specialized REITs, like those that focus on cell towers, which are two of the largest REITS.

Kim Arthur, CEO of Main Management and a pioneer in trading ETFs, said that making real estate a separate sector within the S&P 500 index means that “real estate has moved from alternative investments to traditional.”

Asked how he viewed the change, Edward Mui, equity analyst for financial services at Morningstar, said: 

  • It will be easier for investors to allocate their portfolio between real estate and financial services companies.
  • Real estate should gain more exposure to investors overall as real estate is believed to be historically under-allocated/exposed. Investors who were able to satisfy their financial services sector allocation without paying much attention to real estate will now be forced to get smart on the sector and make those allocation decisions.
  • It shouldn’t affect investment opportunities; companies should still trade within a reasonable range within the intrinsic value of their underlying assets.

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