The long-awaited reclassification of real estate as a separate category within MSCI’s Global Industry Classification Standard is less than a week away, with Sept. 1 marking the date. The carve-out from the financial category occurs at an especially fortuitous time for REITs, as the sector has performed strongly against the S&P 500 for much of the year. Among other effects, the reclassification will boost REITs’ visibility to investors, Stuart Eisenberg, national leader of BDO USA’s real estate practice, tells GlobeSt.com.
Among those paying more attention could be activist investors, says Eisenberg. “There are activist investors and shareholders who are paying attention to REITs now,” he says. But with REITs becoming a stand-alone sector, there may be certain investors who will look at more companies or spend more time looking at that piece, whereas they wouldn’t have looked at it when it was part of the financial sector.” It will enable them to scrutinize “the laggards in that category to focus on them,” along with raising the profile of REITs generally.
“Having the separate sector may draw more analyst coverage,” such that investors will more seriously consider real estate as a play, Eisenberg says. Also, “having that separate sector may drive more ETFs to be formed that would create more liquidity, and more investors looking at that sector. As you start with wider coverage and more specific coverage of that industry, I would expect that the yields for REITs being fairly good right now would attract attention and maybe attract investors, or people who run the larger funds and invest for larger groups into looking at that sector, which wouldn’t be covered right now under a normal allocation.”
There are many positive reasons that investors have been paying REITs more attention, but Eisenberg highlights the fact—one which has also been highlighted in recent media coverage—that “these REITs are professionally run, and that they’ve weathered storms in the past and done a fairly good job of it. So they’ve been able to continue to have returns; they went through the recession like everyone else did and have shown the ability to perform.”
Furthermore, he says, REITs simply constitute a bigger sector today. “The current market cap cap is a tremendous increase from 20 years ago, and there’s a lot of very well-run companies that have a good track record,” says Eisenberg. “This provides a very strong rationale for having a separate sector, because it’s not the same as running a financial company. It’s a different business.” A widely quoted report from Cohen & Steers has projected a $100-billion increase of investor inflows to the REIT sector. However, even with the potential of more capital to spend, Eisenberg expects REITs to maintain their customary levels of discipline.
“They have to be very careful in deploying the money if they raise it,” he says, noting that over the past couple of quarters REITs have been net sellers. “Part of that is that they’ve reached maturity on those investments, but they’re having a hard time finding replacements at an adequate pace. So it’s a matter of not deploying money for the sake of deploying it and raising it just because it’s available. You have to stick to your strategic plan and not utilize funds just because they’re there.”
Providing an additional impetus to not step on the gas is “the uncertainty around interest rates,” says Eisenberg. “Whether or not rates are going to increase significantly over the next couple of years, and how REITs are going to manage that and maintain their distribution, is a challenge.”
Should interest rates spike as the Federal Reserve continues normalizing US fiscal policy, REITs could be hard-pressed to adjust. “But the REITs deploying money and borrowing do so in a manner to reduce their exposure to the increasing rates and manage their cash flow accordingly,” says Eisenberg.
Conversely, he says, “If it’s a linear kind of increase and they can factor it in, the issue is: at what point do interest rates reach a level where cap rates get impacted? That may be a more complicated question. It’s kind of unknown territory right now.”
— Check out REITs Are Outperforming, but Some Sectors Are Stronger Than Others on ThinkAdvisor.