Real estate investment trusts have been hit hard by soaring interest rates. But as the Federal Reserve slows down the pace of monetary tightening, the sector might be set for a rebound .

Sustainability factors, such as the buildings' energy efficiency and how companies manage their human capital, could be a good way to find the winners . For the third year in a row , Barron's has identified the 10 most sustainable U.S. REITs with the help of Calvert Research and Management, a unit of Eaton Vance now owned by Morgan Stanley.

Apartment REIT AvalonBay Communities (ticker: AVB), which was also on the list last year, has jumped to the top spot in 2022, followed by other former top rankers including Kilroy Realty (KRC), Boston Properties (BXP), Host Hotels & Resorts (HST), Ventas (VTR), and Equity Residential (EQR), and Kimco Realty (KIM).

Shopping-mall REIT Brixmor Property Group (BRX), logistics REIT Prologis (PLD), and data-center owner American Tower (AMT) were newly added to the list, taking the seventh, ninth, and 10th place, respectively.

AvalonBay, with 275 operating apartment communities across 12 states, landed the top spot on the list largely thanks to its "terrific" environmental efforts, says Brendan McCarthy, executive director of real-estate research at Calvert.

This includes increasing use of solar energy to power its buildings, improving water efficiency and waste management, as well as investment in climate technology companies to help build resilience. These are particularly important as people shift to work from home and spend more time in their apartments.

Because AvalonBay directly develops many of its properties, the firm has a lot of control over the "embodied" carbon emissions arising from the manufacturing, transportation, installation, maintenance, and disposal of building materials. "They've had a laser focus on integrating embodied carbon into their design process," says McCarthy.

AvalonBay also stands out thanks to its robust cybersecurity program, as data privacy has become an emerging risk for apartment renters. "If you go and rent an apartment, you are giving them a lot of sensitive personally identifiable information, and more and more REITs are using that data to help them price the rent and plan future development," says McCarthy, "There is a great risk of data breach here."

As the heated housing market pushed many potential buyers into the rental market , the apartment owner has performed well financially. In 2022, AvalonBay's funds from operations—a measurement of REIT income and cash flow—grew 19% to a record high of $1.35 billion. However, the stock has tumbled 35% over the past 12 months.

It isn't just AvalonBay. The past year hasn't been easy for real estate investors as rising interest rates made REITs less attractive to dividend investors. Excluding dividends, the FTSE Nareit All Equity REITs index plunged 23% in the past 12 months.

But a tough market doesn't mean business is bad. Landlords are still getting paid rents, if not more than ever. Last year, funds from operations of U.S.-listed REITs was 10% higher from one year ago, while dividends payments rose by 14%.

Their balance sheets are also strong. The REIT sector's debt levels are near historic lows, and a lot of firms have locked in financing for at least seven years, says John Worth, executive vice president for research and investor outreach at the National Association of REITs.

All this means when interest rates fall, REITs are well positioned to outperform. "The fundamentals are there for strong rate-relative performance," says Worth.

Many academic research has shown that real estate firms with strong sustainability programs tend to generate above-average returns. That's because improving sustainability and improving efficiency often go hand in hand. "When we talk to our members, most of their sustainability programs have a positive return on investment," says Worth.

Greener buildings often command above-market rents since they could reduce tenants' utility costs and are less exposed to fluctuations in energy prices, says McCarthy. Meanwhile, strong human-capital management means the company can operate with a leaner, highly-engaged workforce, with less turnover and training costs.

Many tenants and investors also start to care more about REITs' impact on the environment and the communities they operate in, which has pushed companies to be more transparent and accountable. From 2019 to 2022, the share of U.S. REITs that publicly disclose their sustainability goals have jumped from 39% to 83%, according to Nareit.

"I think it's difficult to argue that lowering a company's operating expenses, climate change risk, and insurance premiums is anything but a financial decision," says McCarthy.