Rising rates could eat into one vulnerable set of stocks

If rates continue to rise, the real estate sector could see pain ahead as rising yields may hit names in the sector often seen as fixed income proxies.

As yields bounce meaningfully from their recent 2017 lows, many noted the decline in utilities stocks, which also sport high yields and thus are seen as a potential replacement for bonds. But real estate investment trusts were just behind in performance, pointed out S&P Global portfolio manager Erin Gibbs.

Indeed, the real estate sector fell modestly this week as the yield on the U.S. 10-year Treasury rose. The utilities, consumer staples and real estate sectors are the only sectors in the red over the course of the last week.

If investors continue fleeing bonds, thus pushing rates higher, Gibbs wrote to CNBC in an email, REITs could fall out of favor for two principal reasons.

From an investor demand perspective, REITs offer relatively high dividend yields relative to the rest of the market, and those equity yields could be seen as less attractive as bond yields rise. And from an operations perspective, REITs themselves are often highly leveraged, since they are "borrowing money to finance developments," Gibbs wrote. "As rates increase REITS costs go up, making them less profitable."

When it comes to earnings growth expectations for the next year, the picture is relatively drab for the stocks. Earnings for 2018 have been reduced to "less than half what Wall Street expected in March," Gibbs wrote, with anticipated growth next year coming in a bit under 5 percent.

"Any indication from the Fed next week that a rate [hike] will likely happen in December could push REITs further down. We would be wary of entry point into the sector for the rest of the year," she said, adding that she would expect to see further underperformance from here.

The sector has risen 7.2 percent this year while the S&P 500 has risen 11.5 percent in the same time.



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Michael Santoli

Michael Santoli joined CNBC in October 2015 as a Senior Markets Commentator, based at the network's Global Headquarters in Englewood Cliffs, N.J.  Santoli brings his extensive markets expertise to CNBC's Business Day programming, with a regular appearance on CNBC's “Closing Bell (M-F, 3PM-5PM ET).   In addition, he contributes to CNBCand CNBC PRO, writing regular articles and creating original digital videos.

Previously, Santoli was a Senior Columnist at Yahoo Finance, where he wrote analysis and commentary on the stock market, corporate news and the economy. He also appeared on Yahoo Finance video programs, where he offered insights on the most important business stories of the day, and was a regular contributor to CNBC and other networks.

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