Question: I’ve heard that real estate is being added as a new sector to the stock market. Is this true?
Answer: Yes, you’re right. As of August 31, 2016 stock-exchange listed real estate companies officially became a sector of their own. Prior to this, real estate fell under the financial sector. Some investors thought that real estate was overshadowed and lost by being included with banks and brokerages in the financial sector. Now that companies primarily engaged in real estate and real estate investment trusts (REITs) have their own dedicated sector, their popularity and volatility could likely increase.
A Sunday drive around Naples shows the obvious increase in the construction of not only single and multi-family homes, but continuous care retirement communities (CCRCs) and personal storage facilities as well. It’s evident that demographics and population growth influence real estate development. As demand for real estate intensifies, investor awareness also increases.
For these reasons, and a few more, it’s not a surprise that real estate has earned a place of its own in the Global Industry Classification Standard. Better known as GICS®, this classification system for stock-exchange listed equities worldwide was created in 1999 to provide standardized definitions classifying stocks by industry. This helps investors and financial planners by providing greater organization and structure to the portfolio building process. The original ten industry classifications are Basic Materials, Communication Services, Consumer Cyclical, Consumer Defensive, Energy, Financial Services, Healthcare, Industrials, Technology and Utilities with Real Estate as the newest and eleventh category.
A REIT is a financial instrument that pools investors’ capital to purchase or finance real estate. REITs involve risks with refinancing, economic conditions in the real estate industry, changes in property values and dependency on real estate management. Meanwhile, REITs do possess a unique characteristic that is attractive to some income-seeking investors because REITs are required to distribute 90% of earnings to shareholders.
REITs were developed in the early 1960s when President Dwight D. Eisenhower signed legislation paving the way for their structure as we know them today. There were only 34 REITS in 1971 and by the end of December 2015 this number had grown to 233. According to the Financial Times London Stock Exchange (FTSE) and National Association of Real Estate Investment Trusts (NAREIT), market capitalization growth over this forty-four year period increased from $1.5 Billion to $939 Billion.
So, how does the addition of an eleventh category impact the average investor and financial markets? The answer is “It Depends.” The immediate impact is that some managers and specific products will be required to allocate funds to the new sector. Depending on whether or not any exposure to this area was previously hidden under the financial sector heading will likely influence any changes. This does not imply that all active managers will change their allocations and purchase more REITs. Therefore, the vague answer to the question of “it depends” is appropriate.
Another factorthat may influence REIT markets is that on December 18, 2015 President Obama signed the Protecting Americans from Tax Hikes (PATH) Act. The PATH Act provides new tax incentives to individuals, foreign investors and real estate securities. According to the Senate Finance Committee, the act states that if more than 50% of a REIT is owned domestically, any foreign ownership would be exempt from the Foreign Investment in Real Properties Tax Act (FIRPTA). Interpretation: Foreign pensions and retirement investments in U.S. REITs will no longer be subject to the FIRPTA exit tax. This could be attractive to foreign investors at a time they’re possibly concerned about their currency valuations.
Will this translate into increased foreign demand for U.S. REITs now that real estate has its “own” sector? The answer once again is “it depends.” One objection for not holding REITs is that these companies are often heavily levered or issue more debt as compared to non-REIT companies. Over the long term, managers that might have shied away from using REITs may consider them if underlying objections are resolved. It’s not likely that the index changes alone would cause a large shift as investment managers will likely stay with their present models.
While the new sector could prompt institutional and individual investors to further evaluate REITs, there’s still a need for personalized financial planning, sound investment ideas and intelligent portfolio design. Real estate is just another potential building block in your financial planning strategy. Stay focused and plan accordingly.
Diversification and strategic asset allocation do not ensure a profit or protect against a loss. There is no assurance that any investment strategy will be successful. Information received from outside sources is believed to be credible. The opinions expressed are those of the writer, but not necessarily those of Raymond James and Associates, and subject to change at any time. Material is provided for informational purposes only and does not constitute recommendations, investment advice or an indication of trading intent. Investing always involves risk and no investment strategy can guarantee success. Past performance does not guarantee future results. There is no assurance these trends will continue. Be advised that investments in real estate and in REITs have various risks, including possible lack of liquidity and devaluation based on adverse economic and regulatory changes. Additionally, investments in REITs will fluctuate with the value of the underlying properties, and the price at redemption may be more or less than the original price paid.
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This article provided by Darcie Guerin, CFP®, Vice President, Investments & Branch Manager of Raymond James & Associates, Inc. Member New York Stock Exchange/SIPC 606 Bald Eagle Dr. Suite 401, Marco Island, FL 34145. She may be reached at 239-389-1041, email firstname.lastname@example.org. Website: www.raymondjames.com/Darcie.