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October 21, 2016

Since 1999, and until recently, real estate securities had been classified in the same sector as banks, diversified financials and insurance within the Global Industry Classification Standard (GICS). In mid-September 2016 a new headline sector was added to the existing 10 sectors used to classify and analyse public companies and securities.

This new, eleventh headline sector incorporates equity real estate investment trusts (REITs) and real estate management and development companies, while mortgage REITs remain under the Financials sector. So, why is the reclassification important and what does it mean for real estate investors and developers?

Q: Why is the new classification important?
A: The addition of the new headline sector will increase the exposure and transparency attributed to real estate (which currently sits at US$1.14 trillion) which is expected to increase interest from institutional investors and generalist investors, who will be more likely to make long-term, strategic allocations based on a better understanding of the product. As a result, increased capital will flow into the sector as institutional portfolios and equity funds reallocate capital in order to meet allocation targets. New products will also likely evolve to satisfy this increased appetite for real estate.

Q: What has been the effect of the reclassification, to date?
A: Investor interest in REIT securities and exchange-traded funds (ETFs) increased ahead of the reclassification, resulting in increased net inflows of capital to REIT ETFs by US$641.0 million in the year to September 2016. Some bullish investors who invested early have seen returns three times the performance of the MSCI US REIT index. Furthermore, REIT equity raises in the second quarter of 2016 were up 14.4 percent on the first quarter, and year-to-September 2016 raises were up 20.9 percent.

Q: How much additional capital could flow into the sector?
A: Along with changes to US taxation legislation that makes foreign investment in US REITs more attractive, the reclassification could prompt an inflow of funds into the headline sector – as much as $100 billion – as investors reallocate assets and expand allocations to real estate. Institutional portfolios were under-invested in real estate in 2015 with an average allocation of only 8.5 percent—approximately 110 basis points below target allocations.

Q: How will the reclassification change the offerings in the REIT market?
A: As markets become more educated about real estate, new REITs may emerge that differ from existing general office, industrial and retail-anchored REITs. Investor selectivity is driving an increased focus on more specialised REITs, such as those anchored by data centres.
The increased momentum of listed REITs may also be enough to attract non-traded REITs to list publicly, bringing more IPOs to the market. However, with many listed equity REITs trading at below net asset value, increased privatisations are also a possibility.
Regardless of whether non-traded REITs list or listed REITs are taken private, consolidation within the REIT space is anticipated due to increased transparency and funding.

Q: How will the market evolve, now?
A: As REITs are excluded from the financial sector, their reactivity to volatile market fluctuations will moderate, allowing the performance of the underlying real estate assets to drive the performance of the investment vehicles. Investors seeking cash flow from real estate exposure are able to find diversification and long-term growth in select REITs without having to invest directly in the underlying assets, providing a more liquid investment with less exposure to sector or tenant vulnerability.
In the near term, the new GICS classification will attract more capital into an already-expanding real estate sector, as funds redirect capital allocations and new investors increase participation in the newly formed sector. Changes in REIT products and offerings will likely evolve in the mid- to long-term, as companies adapt long-term strategies to align with market fundamentals, sentiment and opportunities.

Download JLL’s GICS reclassification white paper

Hear more from JLL’s Director of U.S. Investor Research in The Real Deal

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