REITs Hoping to Crash In to the S&P 500 Party
9/7/2001
By JANET MORRISSEY
Dow Jones Newswires
NEW YORK -- Are they in or are they out? That's the question on investors' minds as they count down the final days before Standard & Poor's makes its highly awaited ruling on whether it will finally allow real estate investment trusts into the S&P 500.
A decision is expected in early October, said David Blitzer, chairman of the S&P's index committee.
Mr. Blitzer, whose eight-member committee has been aggressively seeking public comments on the proposal since April, said he's received more than 30 letters and reports, and held meetings with investment banking executives, fund managers and other industry experts on the topic.
Although some market watchers had speculated a decision would come by early September, Mr. Blitzer said he expects to issue a statement at the beginning of October. "It's not realistic" to expect a decision before then, he said.
It's been a long and arduous path for REITs that have been struggling to get into the S&P for many years.
In the past, the index has snubbed REITs, largely due to their relatively small market capitalization and illiquid nature. Some officials had described REITs as being more like closed-end funds than stocks, and some had considered the REITs' use of funds from operations as an earnings measure to be confusing for some investors.
The last time the matter garnered significant attention from the powers that be at the S&P was back in 1995 when Starwood Hotels & Resorts Worldwide Inc., which was then a REIT, acquired ITT, a company that was already in the S&P index. Starwood Chairman Barry Sternlicht was stunned when the index ruled his newly merged company wouldn't have a place in the index.
It's not clear if the reasons for his company's rejection back then were solely related to his company's REIT status. Some industry experts speculated that perturbed index officials frowned on Mr. Sternlicht's public contention that the new company would almost automatically be part of the index even though the committee hadn't yet ruled.
In any event, Mr. Sternlicht has since transformed his company into a standard corporation, which late last year was finally admitted into the index.
In general, companies added to the S&P 500 enjoy greater prestige and a surge in their stock prices. Elliott Shurgin, vice president of index services for the S&P, said companies added to the index in 2000 saw their stocks jump 10% on average between the time the company was named and the time the stock was formally added to the index. (There is generally a lag of five business days between the announcement and the time a name is brought into the index). In 2001, stocks added have advanced 4.6% on average in the week following their acceptance into the index, Mr. Shurgin said.
If REITs get the nod, observers speculate a select group of REITs stand to see big gains, at least in the short term, and the overall REIT sector could potentially enjoy greater and broader investor interest.
Banc of America analyst Lee Schalop, who helped lead this year's lobbying effort to get the issue back onto the S&P agenda, said "broader investor acceptance is the goal." Mr. Schalop, along with a team that included REIT mogul Sam Zell, Alliance Capital fund manager Tyler Smith, Morgan Stanley chief investment strategist Byron Wien and executives from the National Association of Real Estate Investment Trusts, met with S&P Index executives in April.
Much has changed in the REIT world over the past 10 years, and it's important the S&P executives know this, said Mr. Schalop.
First, market caps have been climbing. Nothing illustrated this point more than when Equity Office Properties Trust recently acquired West Coast powerhouse Spieker Properties Inc. to form a company with a total market cap of $28.1 billion and an equity market cap of $15 billion, which far exceeds many names already in the S&P 500. Mr. Shurgin said S&P names generally have equity market caps of at least $4.5 billion.
Also, many REITs, which a decade ago relied on external advisers to manage their assets, today have internal advisers and manage their own properties. As a result, many fund mangers now view REITs as operating companies, rather than simply passive owners of assets.
An IRS ruling in June seemed to back this point further when it ruled that REITs could spin off assets on a tax-free basis. The decision reversed a ruling made back in 1973, which denied such a tax-free spinoff because it didn't consider REITs to be "active" operating companies.
Public Storage Inc. President Harvey Lenkin said REITs are completely different animals than they were 10 years ago. "They're operating businesses, not just passive investors' in real estate," said Lenkin. They also do mergers and acquisitions, issue stock and have actively traded securities that behave similar to S&P stocks. He contends that recent efforts to measure REITs using earnings per share in addition to the FFO metric may bode well for REITs' acceptance by broader-market investors.
Although REITs added to the index would likely enjoy the biggest gains, others in the REIT universe would also benefit.
"Fund managers that use the S&P 500 as a benchmark can completely ignore real estate stocks right now. They're about as relevant as gold coins," said Mr. Schalop. If REITs are brought into the S&P fold, he said, fund managers would be forced to at least track and monitor REITs, even they don't immediately buy them.
S&P's Mr. Blitzer said "the game has changed in the past few years," although he declined to say which way the committee was leaning toward.
If REITs get the go-ahead, names bandied about as possible additions to the index include Equity Office, Equity Residential Properties Trust, Simon Property Group Inc., Archstone Communities Trust, ProLogis Trust and Public Storage.
Write to Janet Morrissey at janet.morrissey@dowjones.com1.
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