Reits eye gain as S&P adds 6 to stock indexes

Real estate investment trusts are finally getting some recognition.

Last week, Standard & Poor’s put six Reits into its stock indexes – one in the S&P 500, three in the MidCap 400 and two in the SmallCap 600.

Experts who follow Reits say that the move will likely have a positive effect on the sector. They say that including Reits in the indexes raises their visibility and desirability.

But some indexing proponents question S&P’s motives. They fear that including Reits in the indexes may be just an attempt to improve performance.

“I’m a little concerned that [S&P is] just chasing the hot sector,” says Mark Hebner, president of Index Funds Advisors Inc. in Newport Beach, Calif.

decline resisted

While the stock market continues to struggle, Reits continue to outperform. They proved their mettle by declining by only 1.4% between Sept. 10 and Sept. 28, compared with a 4.7% drop in the S&P 500, according to a report issued last week by Lehman Brothers Inc. in New York.

Elliott Shurgin, vice president of index services at S&P, acknowledges Reits’ strong performance but says that it had nothing to do with the decision to include them in the indexes.

Mr. Shurgin says that S&P’s decision reflects its recognition that Reits are operating companies, not passive investment companies as some industry-watchers previously held.

Most who follow the Reit sector approve of S&P’s decision to include Reits in its indexes, but some question its selection of Reits.

It added Equity Office Properties Trust in Chicago to the S&P 500; Hospitality Properties Trust in Newton, Mass., and New Plan Excel Realty Trust Inc. in New York to the MidCap 400; and Colonial Properties Trust in Birmingham, Ala., Kilroy Realty Corp. in El Segundo, Calif., and Shurgard Storage Centers Inc. in Seattle to the SmallCap 600.

“Other than the inclusion of Equity Office in the 500 index, the other companies to be included are surprising,” says the Lehman report.

It says some industry-watchers may be disappointed that Reits considered index candidates – Simon Property Group Inc. in Indianapolis, Equity Residentials Properties Trust in Chicago, Public Storage Inc. in Glendale, Calif., and ProLogis Trust in Aurora, Colo. – didn’t make the cut.

That doesn’t diminish the likelihood that Reits will benefit from S&P’s actions, says Robert Steers, president of Cohen & Steers Capital Management Inc. in New York, a money manager that specializes in Reit-oriented mutual funds.

“It’s another step in Reits being thought of as a mainstream asset class,” Mr. Steers says.

S&P’s move may also force Reits to do business differently. S&P intends to use net income to determine the composition of the indexes, the Lehman Brothers report says, possibly setting a new industry standard.

That should provide additional momentum for the industry to agree on a standard definition of earnings based more closely on net income according to generally accepted accounting principles than on the arcane “funds from operations” most commonly used by Reits.