Getting Real with Real Estate

Thampapon / ShutterStock|||

Today we continue our overview of the stock market’s sectors with a look at Real Estate. While investing in land is one of the oldest businesses on earth, Real Estate is actually the newest sector of the stock market under the official GICS classification system. How can this be? Until revisions to the GICS system in 2016, real estate firms were placed in the Financials Sector. Like Financials, Real Estate stocks are highly credit-sensitive and pro-cyclical. Mortgages are one of the most direct links between Federal Reserve policy and consumer spending. But the highly localized dynamics of Real Estate have proved unique enough to warrant their own sector.

Indeed, real estate companies as such are themselves relatively new. Traditionally, real estate investment was conducted either by households, firms investing in their own infrastructure, or perhaps construction firms building for prospective sale. Today, real estate investment is managed by a complex array of real estate investment firms, many of them highly specialized.

Many readers are probably familiar with REIT’s (Real Estate Investment Trusts). These vehicles for real estate investment make up the bulk of this new sector, which also includes some other types of land-investment firm. To make matters just a bit more confusing, not all REIT’s are actually placed in this sector. Mortgage REIT’s are more highly leveraged and exclusively own a portfolio of mortgages. They remain in the Financial sector. The more conservatively leveraged “Equity REIT’s” are the core of the Real Estate Sector. These are the firms owning physical property like malls, hotels, or residential development tracts. Equity REITs still have lots of debt funding their property-based income streams, and a look at the balance sheet is always a must when evaluating these stocks.

Including only this specialized set of firms, the Real Estate Sector is one of the smallest sectors, with a market cap <3% of the S&P500. You’ll often this sector divided into three categories:

• Residential Real Estate
• Commercial Real Estate
• Industrial Real Estate

These divisions are most relevant when considering varied economic data points. Excess inventory could drive falling factory orders mixed with booming retail profits, for instance, causing a surge in commercial real estate even as industrial REIT’s struggled. All three can move in speculative cycles that may or may not match up with the timing of the broader, economy-wide business cycle.

For traditional buy and hold or fund-oriented investors, Real Estate is one of those sectors that need to be approached with the most caution. The entire class of firms is focused on a specific type of asset, rendering it highly volatile (as we saw in the last financial crisis—though REIT’s were still part of Financials at that time). Furthermore, any investor who owns a home already has substantial long-term exposure to this volatile asset class. What’s more, with this sector only recently established, its relationship to broader macroeconomic dynamics isn’t fully understood.

News-based traders have better options for profiting on Real Estate without buy-and-hold volatility. 1-5 day hold times on profitable news events like major property deals can benefit from dramatic price swings without additional long-term exposure to the real estate market.  If you’d like to learn more about using the news to profit on each and every sector of the stock market, we highly recommend one of our complimentary virtual training seminars. We’ll go over the fundamentals of a quantitative trading strategy based on breakthrough academic research. You can claim a place in our next available session using the button below: