MHP Mcgraw Hill Financial, Inc.

By Liam Pleven 

As a weak year for real estate in the stock market comes to a close, the industry is hoping that attention from a new set of investors will send more money flowing its way in 2016.

Starting next summer, MSCI Inc. and S&P Dow Jones Indices LLC, a unit of McGraw Hill Financial Inc. and purveyor of the S&P 500-stock index, will break out real estate into a distinct sector, rather than continuing to lump them in with a broad group of financial firms such as banks and insurance companies.

Investors and analysts expect the change, slated for Aug. 31, to stir interest among investors who might currently overlook real-estate investment trusts, both in the months leading up to the change and afterward.

"It increases the demand for real-estate securities," said Gil Menna, a partner at Goodwin Procter LLP who is chairman of the firm's Real Estate Capital Markets Group. Mr. Menna, who works with some of the nation's largest REITs, says the change has been widely discussed by executives in the industry.

There are currently 10 sectors in the S&P 500. The new real-estate sector would be the second smallest by market value, at 2.6%, just ahead of telecommunications, as of the market close on Nov. 30, according to S&P Dow Jones Indices. Currently, there are 25 companies in the S&P 500 that would be in the new real-estate sector.

The change reflects the increasingly prominent role that real estate plays in the stock market. Though roughly 90% of the commercial property in the U.S. is in private hands, the share held by REITs has grown in recent decades, according to real-estate research firm Green Street Advisors.

Some of the nation's largest landlords are REITs. Simon Property Group, a mall owner that is the largest U.S. REIT by market value, is worth roughly $60 billion, more than some of the 30 blue-chip companies that comprise the Dow Jones Industrial Average.

The new real-estate sector also reflects a greater understanding among investors of how REITs differ from banks and other financial companies, said David Blitzer, chairman of the index committee at S&P, which co-owns the Global Industry Classification Standard with MSCI Inc.

The fortunes of REITs, for example, are tied to the state of the economy and how that affects the rent firms can charge and how much of their space is occupied, said Steve Sakwa, an analyst at Evercore ISI. Banks, by comparison, are affected by demand for loans and the amount of interest they can charge.

The returns of REITs and banks can be similar, as they have been in 2015, when the KBW Bank Index posted a 0.6% decline through Monday, roughly on par with the MSCI US REIT Index's 1.1% drop, according to FactSet.

But the returns can also diverge. In 2014, the REIT Index shot up 25% while the bank index rose just 7.2%, according to FactSet. In 2013, banks gained 35%, but REITs fell 1.4%.

REITs, which must pay out at least 90% of corporate income to shareholders, have also drawn increased attention from yield-starved investors in recent years, said Mr. Blitzer.

"Everyone wants income and yield," he said. "We're hearing it from around the world."

As the change looms, investment firms are rolling out new real-estate funds for individual investors. Nine new real-estate exchange-traded funds opened in 2015, as many as in the five previous years combined, according to investment-research firm Morningstar.

It isn't clear what the immediate effect will be when the change occurs. It is possible that funds that focus on the financial sector and therefore hold REITs will sell off their holdings, which could hit shares in the short term.

That impact could be limited. For example, State Street Global Advisors said in October that its $19.4 billion Financial Select Sector SPDR ETF will continue to hold real-estate stocks after the new sector goes into effect.

But State Street did launch two new ETFs to cover the finance sector and the real-estate sector specifically. The Real Estate Select Sector SPDR Fund has less than $5 million in assets, as of Dec. 21.

Over time, REIT analysts said, investors may notice real estate more and demand that portfolio managers explain how they view it.

"Now, shops have to cover it because it's a stand-alone sector," said Alexander Goldfarb, a senior REIT analyst at Sandler O'Neill + Partners. "It means it's going to get dedicated attention."

Write to Liam Pleven at liam.pleven@wsj.com

(END) Dow Jones Newswires

December 29, 2015 05:44 ET (10:44 GMT)

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