Canada's Bank of Research recently requested investors to take a cautious approach towards the recent rise in the real estate sector, which has been the best-performing sector in the S&P 500, led by struggling sectors like office REITs.

However, analysts at Canada's Bank warn that this momentum may not be sustainable.

While real estate dividend yields seem attractive amid falling interest rates, Canada's Bank states that there are many challenges that could impact the sector.

The memo clarifies that "REITs will struggle if economic growth falters despite interest rate cuts."

The bank explained that historically, REITs tend to outperform just before the first interest rate cut, but they bolster their gains shortly afterwards, a pattern that investors should consider.

Fundamentally, Canada's Bank says that the outlook for real estate is mixed. Although balance sheets remain sound, the company notes that "net operating income is slowing" and margins have only returned to pre-pandemic levels.

Additionally, it is said that pandemic-related disruptions have created pockets of distress within the sector, which are now widening.

Canada's Bank recommends that investors reduce their exposure to certain sub-sectors, including industrial REITs, which face pressures from declining manufacturing and slowing online retail sales, as well as residential REITs, which are dominated by multi-family units suffering from overbuilding, slow rent growth, and rising delinquency rates.

Canada's Bank also added that the office REIT sub-sector is facing headwinds due to rising vacancy rates and an increase in troubled loans.