Ahead of GICS Change, New REIT Investors are a Challenge and a Breath of Fresh Air

As a wave of generalist investors scrutinizes REITs ahead of a planned industry-classification change, established companies and industry veterans are changing the way they do business in response.

S&P Dow Jones Indices and MSCI plan to break real estate out of the Financials sector and into its own category in the Global Industry Classification Standard at the end of August, in a shift expected to draw new investors to a space long dominated by REIT specialists.

In a June 1 SNL Knowledge Center webinar, industry figures said they are already moving to respond to interest from investors who previously kept real estate at arm's length.

David Neithercut, president and CEO of Equity Residential, said his company — the largest multifamily REIT by market capitalization — made repeated efforts to court diversified investors at large funds in recent years. He described the process as "a challenge."

By contrast, since the new GICS sector was announced, "we're getting more and more receptivity, and have had several meetings in the last month with more generalist and diversified investors than we've had in quite some time," Neithercut said.

"I think up to this point, we've been somewhat easy for the generalist diversified investor to sort of ignore, or to not bother with," he said of the REIT space in general, arguing that such disregard "has come at great cost," given REITs' outperformance over the S&P 500 in seven of the last 10 calendar years.

In response to the new interest, Equity Residential has updated the materials it distributes to investors to make them friendlier to generalists, explaining real estate metrics and valuations in more detail, Neithercut said.

I think up to this point, we've been somewhat easy for the generalist diversified investor to sort of ignore, or to not bother with
Traditional REIT-dedicated investors, too, are adjusting to the idea that real estate specialists will soon own a diminished share of the space.

James Kammert, principal and portfolio manager at Harrison Street Securities LLC, said the firm has begun adjusting its investment approach and analytics to evaluate REITs against a broader range of equities. While real estate heuristics remain "very, very important," Kammert said, Harrison Street is seeking the ability to think like a generalist investor, in part so it can make educated decisions about stocks' future values.

New investor interest in REITs is playing out in several different ways, BB&T Capital Markets analyst David Toti said, with some investors who have never owned REITs looking mostly at large-cap "quasi-index" names, and some others who have already owned shares in such companies scrutinizing smaller REITs as a means of generating alpha.

A third type of investor is seeking to underweight REITs, and is learning their vocabulary to explain why, Toti said — though, he added, investors' overwhelming interest is in buying into the space.

In recent months, "I've been spending about 50% of my time talking to generalists, and there's a real interest in understanding the sector, how real estate fundamentals work, how the different subsectors vary in terms of performance and trading patterns," Toti said, calling the new investors' presence "a breath of fresh air."

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"As much as I love the REIT-dedicated community, and I know many of them quite well, it's rare for me to be able to add value in that group, because they know the stocks, they know the space so well," he added. "And so to be able to educate investors on the nuances of the group is really quite a pleasure, and I think ultimately it's really a positive for the space overall, and for the REITs, to have a more diversified investor base."

An open question is whether the predominant reporting metrics in use in the REIT space, including FFO and its variants, will satisfy new investors who are unaccustomed to them. At the moment, those investors are not pushing for different reporting methods, Toti said.

Still, "I think the industry would be very well served to move toward more GAAP-like metrics," he added. "One of the problems in the space, and one of the reasons I still have a job, is companies report a lot of metrics quite differently."

Neithercut maintained, though, that REITs are no different from other sectors in employing industry-specific metrics.

Though the REIT industry should do a better job of explaining FFO, many generalist investors in the past were not motivated to learn about REIT metrics, he added.

"People have just got to be willing to spend the time, and I hope that we're now at a point where people will be willing to spend the time," Neithercut said. "And frankly, it's just not that tough."

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