Is the New GICS Sector Worth $100 Billion?

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In a fitting time almost 25 years after the Kimco IPO kicked off the start of the modern REIT era, the Real Estate sector has matured enough to garner a home of its own.

Later this year, Real Estate will have the honor of being the first new sector created since the Global Industry Classification Standard (GICS) was created in 1999 by MSCI and Standard & Poors. While this is exciting news for public Real Estate and a momentous event, there have been recent reports that suggest up to $100 billion could flow into the REIT market. We have performed an analysis on the potential flows and believe the $100 billion amount to be more hype than reality. Investors planning their portfolios around the expectation of $100 billion in flows might want to re-evaluate their portfolios as we expect the inflows to be far less.

While the $100 billion amount makes for good headlines, we’ve done an analysis and believe the true impact to REITs will be far less.

Why? Generalist investors, meaning non-REIT dedicated investors, have famously been perpetually underweight REITs, much to the detriment of their portfolio returns, because they often don’t understand how to properly value REITs. Some believe that the new Real Estate sector will prompt these investors to increase their allocations to REITs. Several reports have been written on the potential inflows to REITs if they are increased to equal-weight in equity manger portfolios and it seems as if the magic number is $100 billion. That would be a significant boon to an industry worth around $1 trillion today.

But while the $100 billion amount makes for good headlines, we’ve done an analysis and believe the true impact to REITs will be far less. To recap the idea, there are approximately $5 trillion in US mutual funds and the total allocation to Real Estate is approximately 2.5%. However, the market capitalization of the new Real Estate sector is closer to 4.5% of total stock market capitalization. If these funds increased their allocation in REITs to 4.5% due to the increased visibility of Real Estate, then the total buying amount would be a bit more than $100 billion. But we believe the impact will be far less for the following key reasons:

  • Russell Classifications Aren’t Changing – The GICS system is maintained by MSCI and Standard & Poors whereas the other major index firm, Russell, has its own classification system that is not changing at this time. Based on our analysis, approximately 40% of the $5 trillion in assets mentioned earlier are benchmarked to a Russell index. Since Russell is not changing its classification, we don’t see the impetus for these portfolio managers to increase their allocations to REITs. This brings the $100 billion analysis down to approximately $60 billion.
  • Why Now? – Of the remaining $60 billion, it makes sense that there are a number of managers who are underweight REITs as an intentional investment decision and so they would maintain that underweight whether REITs have their own sector or not, further reducing the amount of flows into REITs. Regrettably, we doubt all of these investment managers are going to wake up one day and decide to increase their weighting in REITs because of an index classification change.
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Given that analysis, we don’t expect a large, market-moving event later this year when the Real Estate sector comes into existence. We think a more optimistic scenario is that between 20% to 50% of the $60 billion might increase their allocations to real estate over time as investors become more familiar with REITs, which means potentially $10 to $30 billion in positive flows from the new GICS classification.

So what does this new classification really mean for the REIT space? The creation of the Real Estate sector is positive in the long run primarily because of what we, as a real estate investment firm, have been preaching for years:

Real Estate is a distinct asset class.

As we’ve seen over the lifetime of REITs, they offer significant benefits in a portfolio given their strong historical returns, lower correlations, and higher dividend yields. We believe the creation of a Real Estate GICS sector is validation of the need for REITs to be included in any properly diversified portfolios.