Reclassifying Real Estate
Joseph A. Davis, CDFA®
October 19, 2016
S&P Dow Jones Indices and MSCI are moving publicly traded real estate investment trusts (REITs) and other listed real estate companies from the Financials sector to a distinct Real Estate sector. In September 2016, there will be 11 headline sectors instead of 10; this is the first time a new sector has been added to the Global Industry Classification Standard (GICS) since it was created in 1999.1
The GICS is often used as a framework for portfolio construction. By some estimates, fund managers could shift as much as $100 billion to the Real Estate sector in a collective effort to follow the market weightings of various indexes.2
By drawing more attention to equity REITs as income-generating assets with the potential for capital appreciation, the change might also affect the asset allocation decisions of some individual investors.
A REIT is a company that uses the combined capital of a large number of investors to buy and manage income properties such as apartments, shopping centers, hotels, offices, and other types of residential, commercial, and industrial buildings. Publicly traded REIT shares can generally be bought or sold on an exchange at a moment’s notice, making them more liquid than physical real estate investments, which involve transactions that can take months to complete.
Many REITs generate a reliable income stream regardless of share price performance, primarily because they are required by law to pay out 90% of their taxable incomes as dividends to stakeholders. In the first quarter of 2016, the S&P REIT index had a dividend yield of 3.9%.3 The performance of an unmanaged index is not indicative of the performance of any specific security. Individuals cannot invest directly in an index.
REIT share prices can be sensitive to interest rates. As rates rise, steady dividends may appear less attractive to investors relative to the safety of bonds offering similar yields. On the other hand, current fundamentals, including modest economic growth, lower unemployment, and rising rents, are generally seen as positive conditions for REITs and other real estate businesses.
Many REITs generate a reliable income stream regardless of share price performance, primarily because they are required by law to pay out 90% of their taxable incomes as dividends to stakeholders.
Breaking real estate out of the Financials sector acknowledges that the industry’s business models and ties to underlying property markets produce a distinctive risk-return profile, including a relatively low correlation to the rest of the stock market.4 Because the share prices of equity REITs don’t rise and fall in lockstep with the broader stock market, including them in your portfolio could help reduce the overall level of risk.
The return and principal value of all stocks, including REITs, fluctuate with changes in market conditions. Shares, when sold, may be worth more or less than their original cost. Diversification and asset allocation do not guarantee a profit or protect against investment loss; they are methods used to help manage investment risk.
REIT distributions are taxable to the extent they include any ordinary income and capital gains. Some REITs may not qualify as a REIT as defined in the tax code, which could affect operations and negatively impact the ability to make distributions.
There are inherent risks associated with real estate investments that could have an adverse effect on financial performance. Such risks may include a deterioration in the economy or local real estate conditions; tenant defaults; property mismanagement; and changes in operating expenses (including insurance costs, energy prices, real estate taxes, and the cost of compliance with laws, regulations, and government policies).
1, 3) S&P Dow Jones Indices, 2015–2016
2) Investor’s Business Daily, March 18, 2016
4) FinancialAdvisor.com, March 1, 2016
The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. Copyright 2016 Emerald Connect, LLC.
Throughout the past two and a half months I have continued to ask myself, did we jump off a financial cliff? The answer was no. How did I know? The answer, while somewhat complex, is profoundly simple.
While it’s true that retirement accounts can be used to save for college, there may be negative consequences to doing so. It’s best to talk with a financial professional to determine the appropriate course of action and to make sure you’re on track to meet your goals.
A 401(k) isn’t the only option for retirement, but it’s definitely one of the most attractive. In many cases, it offers free money and is relatively easy to roll over when you change jobs. A financial professional can help you prepare for retirement with a 401(k) that fits your current investment style and stage in life and adapts to changes in career or investment styles.
Qualified plans, such as 401(k), profit sharing, defined benefit pension and money purchase pension plans, have defined benefits or defined contributions. A qualified domestic relations order, or QDRO, is required when dividing qualified plans.
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