On Aug. 31, publicly-traded real estate companies graduated out of the financial services sector into a sector of their own. How has the newest S&P 500 sector performed? The short answer is not so well.
A historic change came to the S&P 500 on August 31, when publicly-traded real estate investment trusts (REITs) joined the ten broad market categories tracked by the popular stock market index. The move to recognize an eleventh sector on the S&P 500 could have broad ramifications on the stock market, with industry analysts predicting substantial inflows into real estate.
Just how much inflow the newly created sector will generate is subject to speculation. JPMorgan Chase forecasts as much as $100 billion could flow into REITs. Others have offered much more conservative estimates, with Goldman Sachs putting the number closer to $19 billion and Bank of America Merrill Lynch expecting no more than $8 billion to come in.
While the move to recognize an eleventh component appears cosmetic, it is the first time since 1999 that S&P has deviated from its main sector mapping. Since real estate was previously part of the financial services sector, the change forced fund managers to rebalance portfolios.
Under the new categorization, two industries are being tracked under real estate: equity real estate investment trusts and real estate management and development companies. Combined, the sector has a market capitalization of nearly $1.1 trillion as of May 19, the smallest of the 11 main sectors. By comparison, financials have a market cap of $6.8 trillion. Information technology is the largest at more than $7.2 trillion.
The new breakdown and weighting look like this:
Though now accounting for a smaller portion of the large-cap index, financials have been on a tear since the November presidential election. In fact, most of the S&P 500 sectors have performed very well since Donald Trump won the nomination, but gains in financial shares have been especially dramatic. The sector has returned more than 25% over the past 12 months, with the bulk of the gains coming after November. The only sector to outperform financials during this period is information technology, which has returned more than 35%.
However, those gains have failed to rub off on real estate, which has struggled since being given its own sector. The S&P 500’s real estate component has lost more than 1% since its inception:
But REITs have rebounded since the start of the year to outperform financial stocks as a collective:
Clearly, real estate stocks have struggled for gains since September, and continue to be among the worst performers on Wall Street. Analysts ascribe the sector’s weaker performance to rising interest rates. Since real estate was incorporated into the S&P 500, the Federal Reserve has raised interest rates on two occasions. A third interest rate hike is expected next month, based on the latest Fed Fund futures prices. One additional upward adjustment before the end of the year is also being priced in.
Still, real estate carries a much higher dividend yield than the broader S&P 500 (3.6% vs. 2.1% for the large-cap index). Real estate has also returned something crazy like 400% over the past seven-and-a-half years. Gains anywhere near that magnitude will be difficult if not impossible in the current macro environment.
The need to recognize real estate as an eleventh sector highlights the importance of REITs to investors. Real estate, which first joined the S&P 500 in 2001, is now considered an essential element of many well-balanced portfolios. Although the sector’s results have been underwhelming these past nine months, we shouldn’t be hasty to draw conclusions about its long-term viability. After all, hasty conclusions when stock picking rarely benefit the picker.