As the economy revs up, so does talk of an interest rate hike. For advisors cobbling together a retirement portfolio for their clients, the question becomes: How will the different investment classes perform in a rising interest rate environment? For publicly traded real estate investment trusts (REITs), rising interest rates typically foster mixed results. Yet, according to the experts, REITs remain a vital part of retirement investment holdings because of their ability to diversify and stabilize a portfolio.

Quarterly statistics from the National Association of Real Estate Investment Trusts (NAREIT) indicate the sector has slumped in recent months. In the second quarter (as of June 29), total returns (the share price movement plus dividends paid) for the FTSE NAREIT All Equity REITs index slid down 9.17% (even though they were up 3.98% in Q1). That drop was due mostly to REIT stock price returns, which declined 10.03%; dividend yields, meanwhile, rose 3.88%. Likewise, Morningstar had charted a 3.11% dip in U.S. open-end real estate fund returns for the year by the end of June.

A May report from Lipper further documents investors’ retreat from the class. Net redemptions from equity real estate funds stood at $852 million, one of the largest drops in the equity funds sector. Real estate as a subsector didn’t fare much better on the equity ETF side. There, real estate ETFs amassed nearly $1.1 billion in net redemptions.

When talk of rising interest rates swirls, investors tend to exit REITs, confirms Brad Case, NAREIT’s senior vice president of research and industry information. Yet he asserts investors may be mistaken in the belief that an interest rate hike portends a significant negative impact on the REIT sector. “That was the pattern we saw in 2013, when REITs fell in May with the Fed’s announcement it would consider raising rates,” Case recalls. “But [the sector] recovered by year-end and went on to deliver a 28% gain in 2014.”

Even if the Fed hikes rates, Scott Crowe, global portfolio manager for Resource Real Estate, does not foresee the 10-year Treasury rate shooting up to 3% or 4%. He oversees a global publicly traded REIT fund and an income fund that invests in both public and private real estate assets.

In the near term, Crowe says investors in commercial real estate can seize some fairly attractive yield spreads over other asset classes. He estimates the global average yield for the sector rests around 3.5%. “That is low by historical standards,” he says, “but every yield is low by historical standards.” By comparison, yields for 10-year bonds and equities hover around 2%, he notes.

Crowe emphasizes REITs are more than just a dividend yield play. REITs retain approximately 40% of their cash flow, which enables them to reinvest in their properties and acquire new assets. By doing so, REITs provide investors with a growth story.

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