A New Role for REITs?

08/30/2016 9:00 am EST

Focus: REITS

Ron Rowland

Editor, All Star Fund Trader

Important changes are coming to way that real estate investment trusts are categorized within the financial sector; the better understand these developments, we turn to sector expert Ron Rowland, editor of All Star Investor.

The Global Industry Classification Standard (“GICS”) system is implementing a significant change over the coming weeks. 

GICS was jointly developed by Standard & Poor’s and MSCI and is the primary system used by institutional investors to categorize stocks into their respective industries and sectors. The big change is the addition of Real Estate as the 11th sector­.

REITs are already included in the GICS system, but they currently reside within the Financials sector.  After the change, most REITs will belong to the new Real Estate sector classification. 

The primary exception to this are the mortgage REITs. Mortgage REITs, as the name implies, are companies that invest in real estate mortgages instead of buying actual properties.

That makes them similar to a lender, and therefore they will continue to be part of the Financials sector.

These classification changes will take effect on August 31, 2016.  However, most of the affected indexes will not implement the change until September 16, and ETFs tracking the changed indexes all have their own timetables.

What will happen to the financial services ETFs in your portfolio?  The answer is, “it depends.”  Pay attention to your brokerage statements and notifications from ETF sponsors for possible clues. 

However, you may need to go to the sponsor’s website to get the full details.  Today, some websites have little or no information available, and some prospectus updates only say that change is coming. Hopefully, this will improve over the next few weeks.

Vanguard plans to shift about a quarter of the assets, those representing REITs, from the Vanguard Financials ETF (VFH) to the Vanguard Real Estate ETF (VNQ) at the next quarterly rebalancing. 

At that time, VFH will no longer provide any exposure to REITs for its shareholders. VFH shareholders wanting to get back to their prior allocations will need to sell about a fourth of their VFH holdings and redeploy the proceeds into VNQ.

Guggenheim and State Street SPDRs are making the transition much easier for investors. 

Instead of placing the reallocation burden on shareholders, owners of the popular Financial Select Sector SPDR (XLF) and the Guggenheim S&P 500 Equal Weight Financials ETF (RYF) will receive special distributions consisting of shares in their respective real estate ETFs. 

XLF owners will receive shares of the Real Estate Select Sector SPDR (XLRE), and RYF owners will get shares of Guggenheim S&P 500 Equal Weight Real Estate ETF (EWRE).

Some market observers are claiming these changes will spark a lot of buying in REITs. However, I’m going to take the other side of that argument. 

In theory, these index and ETF changes should not generate any net buying of REITs. The quantity and allocation of REITs within the S&P 500 is not changing. 

Therefore, all of the REITs being purchased by various real estate index funds should be equal to the REITs being sold by the financial services funds. 

Yes, the REITs will end up in different places (funds), but the GICS change will not be creating any more REITs.

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By Ron Rowland, Editor of All Star Investor

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