T
he real estate sector has significantly underperformed the S&P 500 over recent years. To put this into perspective, a $1,000 investment in the Vanguard Real Estate ETF (VNQ) made a decade ago would now be worth around $1,770, assuming dividend reinvestment.

    While this isn't a loss, it's far from stellar performance when compared to investing in an S&P 500 index fund like the Vanguard S&P 500 ETF (VOO), which would have grown to approximately $3,900 over the same period. The real estate sector's underperformance can be attributed to two main factors: the S&P 500's remarkable bull run and the sector's sensitivity to interest rates.

    The past decade has seen two prolonged periods of Federal Reserve rate increases, with a global pandemic in between, resulting in a benchmark federal funds rate more than 400 basis points higher than it was a decade ago. Real estate investment trusts (REITs) tend to underperform when rates are high or rising due to increased borrowing costs and pressure on commercial property values.

    These factors can also become catalysts for real estate growth in falling-rate environments, making interest rates a crucial consideration for investors in the sector.