For income-focused investors who turned to real estate investment trusts for yield and diversification, 2025 has been a year of frustration. While the S&P 500 surged nearly 17% to record highs, the Morningstar US Real Estate Index managed a gain of just 4.6% through mid-December—a gap of more than 12 percentage points that represents one of the widest underperformances in recent memory.

The REIT sector's struggles stem from a confluence of factors: persistent interest rate pressure, ongoing challenges in office real estate, and competition from other income-generating investments that now offer attractive yields without real estate's complications.

Why REITs Struggled in 2025

Real estate investment trusts face a fundamental challenge in an environment of elevated interest rates. REITs typically carry significant debt to finance property acquisitions, and higher rates increase borrowing costs while compressing the value of existing properties. Even with the Federal Reserve cutting rates three times in 2025, the 10-year Treasury yield—which heavily influences commercial real estate valuations—remained stubbornly above 4%.

The Office Problem That Won't Go Away

Office REITs have been in crisis mode since the pandemic, and 2025 brought little relief. Remote and hybrid work arrangements have permanently reduced demand for traditional office space, leaving vacancy rates elevated in markets from San Francisco to Manhattan.

J.P. Morgan Research expects office vacancy rates to peak in late 2025 or early 2026, but "peak" doesn't mean "solved." Many leases signed before the pandemic are only now expiring, meaning the full impact of changed work patterns has yet to hit landlords' bottom lines.

"Leasing activity is starting to pick up, but we expect vacancy rates to remain elevated well into 2026. The office sector faces a prolonged adjustment period."

— J.P. Morgan Research

Data Centers: Not the Salvation Expected

One bright spot was supposed to be data center REITs, benefiting from the explosion in artificial intelligence computing demand. Yet even here, results have disappointed. Equinix, the world's largest data center operator, saw its stock decline roughly 20% year-to-date despite solid booking growth and healthy demand.

The issue isn't demand—it's supply. Companies are racing to build data centers to capture AI-driven growth, and concerns about oversupply have kept valuations in check. The sector also faces growing scrutiny over its enormous power consumption, with some jurisdictions limiting new data center development due to strain on electrical grids.

The Yield Competition Problem

REITs have historically attracted investors seeking yields higher than bonds while accepting more volatility than fixed income. But with Treasury bonds yielding 4%+ and investment-grade corporate bonds offering even more, the risk-reward proposition for REITs has become less compelling.

Why accept real estate risk when you can earn similar yields from government-backed securities? That question has led many investors to reduce REIT allocations in favor of fixed income alternatives.

Current Yield Comparison

  • 10-Year Treasury: Approximately 4.1%
  • Investment Grade Corporate Bonds: 4.5-5.5%
  • Equity REITs (average): Approximately 3.9%
  • Mortgage REITs (average): Approximately 10.4%

Mortgage REITs offer higher yields but come with significant interest rate risk and leverage concerns. Their 2025 performance has been mixed, with some posting solid gains while others struggled with spread compression.

Bright Spots in the REIT Universe

Not all real estate subsectors have suffered equally. Some areas have delivered solid returns despite the broader sector's struggles.

Retail REITs: A Surprising Comeback

Retail REITs, left for dead during the e-commerce surge of the 2010s, have quietly recovered. Strip centers and neighborhood shopping centers, in particular, have benefited from limited new supply and steady tenant demand from services and dining establishments that can't be replicated online.

The irony is thick: the "death of retail" narrative proved overblown, while office real estate—once considered bulletproof—faces existential questions.

Healthcare REITs: Demographics as Destiny

REITs focused on senior housing, medical office buildings, and skilled nursing facilities have benefited from aging demographics and steady healthcare spending. The sector isn't immune to interest rate pressure, but underlying demand fundamentals remain strong.

Industrial REITs: E-Commerce Infrastructure

Warehouse and logistics REITs continue to benefit from e-commerce growth and supply chain restructuring. While growth has moderated from the pandemic surge, fundamentals remain healthy.

What J.P. Morgan Expects for 2026

J.P. Morgan Research anticipates REIT earnings growth of approximately 3% in 2025, with similar modest growth expected in 2026. The outlook reflects stable fundamentals but continued headwinds from interest rates and office challenges.

For investors, this suggests a sector that may offer steady income but limited capital appreciation potential in the near term.

Should You Own REITs Now?

The case for REITs in a portfolio remains valid despite the 2025 underperformance. Real estate provides genuine diversification, as its returns are driven by factors different from those affecting stocks and bonds. The income stream from REIT dividends can be attractive for retirees and other income-focused investors.

Considerations for REIT Investors

  • Be selective: The REIT universe is diverse. Avoid troubled subsectors like office while considering stronger areas like industrial, healthcare, and select retail
  • Focus on quality: Strong balance sheets matter more in a high-rate environment. Look for REITs with manageable debt levels and well-staggered maturities
  • Don't chase yield: The highest-yielding REITs often carry the most risk. A more moderate yield from a stable company may serve you better
  • Consider your time horizon: Real estate investments typically reward patience. If you need liquidity soon, REITs may not be appropriate
  • Size appropriately: Most advisors suggest limiting real estate to 5-15% of a diversified portfolio

The Contrarian View

Some investors see REIT underperformance as a buying opportunity. Valuations have compressed to levels that embed significant pessimism about the sector's future. If interest rates decline further in 2026 or office markets stabilize faster than expected, REITs could rally sharply.

The REIT sector collectively owns more than $4.5 trillion in gross real estate assets across the United States. These properties aren't going anywhere, and in many cases, they generate steady cash flows that support dividend payments regardless of stock price fluctuations.

For long-term investors willing to look past the current challenges, 2025's underperformance might eventually be seen as an attractive entry point. But timing real estate cycles is notoriously difficult, and the factors that pressured REITs in 2025—elevated rates, office market stress, and yield competition—show few signs of disappearing soon.

The bottom line: REITs remain a valid component of a diversified portfolio, but they're unlikely to be a performance leader until interest rates decline meaningfully and the office sector finds a new equilibrium. For most investors, the right approach is selective exposure to stronger subsectors rather than broad-based REIT index funds that carry heavy office exposure.