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REIT reclassification good news, BMO says

A rising tide lifts all boats and that’s expected to be the case for the stock market reorganizat...

A rising tide lifts all boats and that’s expected to be the case for the stock market reorganization planned for this September.

GIC TriangleThat’s when investors will see the establishment of real estate as a separate, stand-alone sector under the Global Industry Classification System (GICS). Currently, real estate companies and REITs are grouped with (and dominated by) financial services companies.

REITs, most notably RioCan, could also get some love from the Toronto Stock Exchange, said Heather Kirk, managing director of BMO Capital Markets’ real estate and REIT research.

“Our index team believes that RioCan, potentially some others, will be added to the TSX 60. The first REITs in the TSX 60. I think that will make a difference. Clearly when you get index additions you get additional fund flow.”

RioCan will not be the only winner, she added.

 “Everyone gets pulled up” in a coattail effect in terms of share prices if RioCan is added to the TSX major index she said.

The pullup effect

In a recent investor presentation, Kirk and her analyst team showed that big Canadian investors are underweight the real estate sector, with mutual funds estimated to be underweight the sector by about 1.7%.

BMO found of 571 Canadian equity funds with total assets under management of $280 billion, 26% had no real estate weighting and 36% had no REIT weighting.

In all, 21 real estate entities will be removed from financials: 16 REITs with an average yield of 6.1%, and five real estate operating or services companies with an average yield of 2.4%, according to BMO.

The biggest component of real estate is Brookfield Asset Management, which accounts for 40% of real estate weight and drives down the sector’s average yield by 140 basis points.

Brookfield’s dominance of the real estate sector could be challenged, however. “We have heard that there has been some lobbying to have them removed from the weighting and to have them not be classified as real estate,” said Kirk.

What does it mean?

Putting real estate into a separate category is expected to mean increased capital flow into the companies, as much as US$100 billion in new money according to some research.

That estimate may be high, said Heather Kirk, but the GICS reclassification has to be viewed as an overall positive for public real estate companies.

“It is definitely a plus, in the same way as when they added [real estate companies] to the S&P 500, anything that can raise the profile is good.”

It will show up in the holdings of funds that have been holding financials but avoiding real estate until now because they were not part of a separate index.

“You could say that you were market weight financials – when what you were really saying was – you were massively underweight REITs and overweight banks and insurance.”

The difficulty of estimating the ultimate impact of the reclassification is that not all funds are obligated to mirror the market’s sector weightings, she added.

“But what is different, is when you are typically managing a fund, you have consultants who are going to sit down with you and say, `Why do you have no real estate weighting?’”

For those firms who avoided real estate and loaded up on financials, they will now have to justify or at least acknowledge that decision come September.

“The tide has gone out.”

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