Real estate investment trust ETFs have been hammered by rising rates, and their performance is threatening to swing negative for 2013.

The $3.9 billion iShares US Real Estate (NYSEArca: IYR), one of the largest ETFs in the REIT category, has a year-to-date total return of 1.7%, according to Morningstar. Meanwhile, SPDR S&P 500 ETF (NYSEArca: SPY) is up about 20%.

IYR pays a 30-day SEC yield of 3.94%, according to manager BlackRock.

“The biggest risk to the sector is the prospect of rising interest rates. When rates rise, REITs will have to allocate more cash to debt servicing and less to business reinvestment and dividend payouts to investors,” says Morningstar analyst Abby Woodham. “Higher rates will also make REIT yields less attractive, putting downward pressure on the sector’s valuation.”

Other commercial real estate ETFs include Vanguard REIT Index (NYSEArca: VNQ) and SPDR Dow Jones REIT (NYSEArca: RWR). [Diversified REIT ETFs for Dividend Yields]

“What I think is most important about the stock performance over the last couple of months is that the market is obviously very focused on the move in interest rates, and it’s having an impact on the sector,” said Anthony Paolone, an analyst with J.P. Morgan, in a report. “You’ll have a lot of generalist investors who are not going to have a good feeling about commercial real estate and deploying capital into REIT stocks – for right or wrong – if they feel that interest rates are going higher over the near term.”

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