By Sinéad Carew

The S&P 500 real estate index lost 0.7% on Friday after falling 3.5% on Thursday, which was its biggest daily decline since March when the banking sector was in crisis.

The U.S. Treasury 10-year yield, fell slightly on Friday, after rising on Thursday to around 4.5%, its highest since 2007. This provided tempting returns for fixed-income assets, making the relatively high dividend payouts of Real Estate Investment Trusts (REITs) a little less tempting.

REITs also tend to borrow heavily so the prospect of higher rates for longer puts pressure on their profit outlook. While the Fed decided not to hike interest rates after its meeting on Wednesday, it indicated that rates could stay at elevated levels for longer than investors had expected.

"Not only are REIT's bond substitutes but they also rely on borrowing so that just makes them doubly interest-rate-sensitive," said Jack Ablin, chief investment officer of Cresset Capital who says that even though the sector seems cheap by some measures, he is not ready to step in right now.

The S&P 500 real estate index is the second weakest performer among the benchmark S&P 500's 11 major sectors with a decline 6.5% so far this year, second only to utilities' 10.3% drop. This compares with year-to-date a gain of about 15% for the benchmark index.

But Gina Szymanksi, portfolio manager for REITs at AEW Capital Management, said she expects Treasury yields will peak around current levels, which will help REIT stocks that have "already baked in" 10-year Treasury yields in this range.

"The knee-jerk reaction is, as interest rates rise, you sell REITs. It's not totally unrealistic. They are capital intensive businesses that require financing," said Szymanski, adding that if 10-year yields rise sharply from here it would add pressure to REIT stocks.

But if the economy weakens, REITs often outperform.

"When the Fed tries to slow the economy, it's usually successful. That usually results in declining earnings for companies in general and when that happens it's the time for REITs to shine," says Szymanksi who estimates a roughly 20% total return for real estate stocks in the next two years.

On Friday the biggest real estate loser was American Tower, which finished down 1.8% while the biggest gainer was Extra Space Storage, up 1.2%.

Alexandria Real Estate Equities fell 1.6% on Friday, after losing 8% on Thursday and hitting its lowest level since 2016.

(Reporting By Sinéad Carew, editing by Lance Tupper and David Gregorio)