How is the S&P 500 REIT Index Determined

REIT

The S&P 500 REIT Index is a stock market index that is used to measure the performance of the stock of 500 large REITs which are listed on United States stock exchanges. It is an equity index that focuses on the entirety of all publicly traded real estate investment trusts, or REITs in the United States, according to SP Global. To cut through the rhetoric, it’s not a list of the top 500 REITs on the stock market at any given point in time, but rather, REITs are included in the larger S&P 500 Index, and they make up a tiny portion of the larger index. A commonly asked question is how it this index determined? What is required for a real estate investment trust to become a part of this listing? We answer these questions with a look at the process and methods for inclusion in the index, along with incidental information to enhance your knowledge and understanding of how the S&P makes this determination.

The S&P has its own methodology for determining this index

Our research led us to a few different Indexes to get an idea of how REITs are ranked for inclusion in the top performance lists. We observed that each organization has its own distinct formula for arriving at its determination. The commonalities include gathering performance data and valuation figures from all REITs registered on the stock market, but there are variations within the methods. For example, the Crisp method, follows a 3-step process including a set to $100 in cumulative value of the portfolio as of December 30, 1994, with a calculation of returns for individual securities, then for returns for indexes, then calculation of index levels.

How does the S&P determine which REITs to include?

According to an executive with Index Funds Advisors Inc, it is believed that the S&P may base the decision to include REITs in the indexes to help improve performance. Other analysts agree that inclusion of REITs makes them more visible to investors and more desirable, having a positive effect on the real estate sector. These are assumptions made by experts and analysts within the financial arena and their views amount to educated speculation, but when it comes to investing and understanding the inner workings of the market and its systems, much of what takes place is fueled by speculations. All are points worthy of consideration, but as intangibles and opinions, they must, as many aspects of the market, be weighted by discretion, filed away as data for consideration.

S&Ps methodology

According to Morningstar, a committee is appointed to review the status of the index and discuss which companies should be included. REITs included in this list are weighed with regard to their market size, liquidity, and representation of the respective group. New companies can only be added when there is a space created by a previously indexed company that is dropped from the list due to business failure, which is rare, or because of mergers. It is not necessarily the largest companies that are considered for inclusion. The committee meets monthly to consider and discuss possible changes to the S&P index. Only U.S. based companies are eligible for consideration. The majority of companies included are large cap as they tend to positively impact overall performance.

REITs are a recent inclusion in the S&P index

Companies involved in real estate were previously excluded from inclusion in the S&P index. This changed in October of 2001, according to NAREIT. REITs have only been allowed for just under 20 years. When you consider that the S&P 500 Index has been around since 1957, this does show how it is evolving with the changing times. Making provisions for sectors deemed relevant does show an open-minded approach on the part of the committee. Since the limits were lifted, the rate of inclusion for REITs rose from .2% in 2001, to 2.8% by then end of 2019. The constituent REITs market value increased from $20 billion to a remarkable $773 billion, due to the adoption of the REIT Model.

What is the REIT model?

The REIT model is a method for comparing how companies in the real estate sector of the market compare to other sectors included in the S&P 500 GICS sectors. It is determined by comparing the $294 billion market cap of Data Centers, Infrastructure, Timberland REITs, and Specialty REITs to the aforementioned sectors. As of the end of 2019, REITs make up 3% of the S&P 500 Index. Although these limitations sound restrictive, they actually encompass a large range of real estate involvements. REITs now have a shot at representation in the Index when previously they did not.

Conclusion

Although some formulations for the methodology used to add companies to stock indexes are complicated, they can be easily explained. One must understand, at least for the S&P, the rationale behind the decisions made to include a company to the 500 Index. The decision to add an REIT in the place of an outgoing company is weighted upon multiple factors, perhaps the largest being how well it represents the group of other REITs within its respective sector. Although there is concern over committee members seeking to increase visibility and desirability of the stock within a particular company, the methods for inclusion cannot be reduced to a single compelling factor. It’s about performance and representation, not perhaps so much the elevation of a sector, although this certainly can be the end result. Companies fall from the distinguished list, but the methods, at least to us, suggest that they are fueled more by the need to have relevant sector representation. This is good news for investors who are interested in diversifying because he information is useful in the decision making process involved in whether or not to invest in a particular REIT, and which one may be the best option.


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