The best-performing asset class of the past five years is the shops, industrial properties and office blocks owned by Australian real estate investment trusts (A-REITs). The Australian-sharemarket-listed A-REITs have produced an average annual return of just under 17 per cent over the five-years to March 31 this year. That's even ahead of the 16.1 per cent return, including rental income, for Sydney dwellings, which includes houses and units. Winston Sammut, managing director of Folkestone Maxim Asset Management, a specialist property fund manager, says the main factor in the good performance of A-REITs is the low interest rates that make the yields on the Australian property trusts attractive to investors. Sammut says commercial property, such as office blocks in Sydney and Melbourne, have done particularly well because of a reduction of commercial space as those spaces have been converted to residential developments. But investors should not chase past returns, as experts warn with interest rates set to rise, A-REITs are unlikely to repeat their stellar performance of recent years. \nSavvy investor A wealthy private investor, who does not want to be named, has done very well out of the Australian-listed property trusts that he holds in his self-managed super fund. The sector was beaten up badly during the global financial crisis and since then they have much lower levels of borrowings, he says. They produce reliable income streams, but the Sydneysider has been surprised by the extent of capital growth. "My most significant holding is the ALE Property Group, which owns the old Foster's pubs and is my best-performing A-REIT," he says. The investor invested in ALE in 2003 when it floated on the sharemarket and he estimates that he has made several times his original investment, including distributions, over that time. "I'm not expecting the returns from A-REITs to be anywhere as good from here," he says. He thinks that they are "expensively priced" at the moment. "But the yield alone at about 5 per cent, which is more than a term deposit, is not bad," he adds. \nAustralian shares The broader Australian sharemarket has also done very well, producing a return of just over 11 per cent over the period. "It has been a good period for Australian investors and for super as well," says Shane Oliver, the chief economist at AMP Capital Investors. Reflecting the good performances of "growth' investments across the board, "balanced" investment options of super funds, where most people have their money, have produced an average annual return over the five years of 9.2 per cent. As well as most overseas investments doing very well in their local currencies, Australian investors have received a boost as the value of the Australian dollar against the US dollar has fallen over the five years. Global shares in local currency terms returned 11.6 per cent while global shares in Australian dollars returned 16.4 per cent - the second-best performing investment for Australian investors behind A-REITs. All returns are given as "total" returns, which assumes income distributions, such as dividends, and rents from properties are included. Investors have been seeking out investments that pay a higher yield as interest rates have been falling around the world over the past five years, including in Australia, where the cash rate is at a record low of 1.5 per cent. Oliver says the other reasons for the good returns include that five years ago investors were worried by the eurozone debt crises and continuing worries about the world economy after the worst of the global financial crisis. Those worries have mostly passed and the US economy is growing strongly. \nRates to rise Jonathan Philpot, a partner at HLB Mann Judd Wealth Management NSW, says interest rates have probably bottomed and will eventually rise. He thinks the cash rate could rise to 3 per cent over the next several years. Interest rates are already going up overseas, which is one of the reasons he is not expecting the returns to be as good over the next five years. "We are expecting average annual returns of between 8 and 10 per cent for the Australian sharemarket of which 5 per cent of that is dividends, including franking credits," Philpot says. Tony Davison, general manager and senior financial adviser at Henderson Maxwell, says he is expecting A-REITs to not do nearly as well as interest rates rise. "The fundamentals of the assets themselves are sound; it's just an interest rate argument," he says. Davison says that higher interest rates will induce volatility in all asset classes, at least initially, until the valuations "re-set" after which time investment markets should "normalise". \nHouse prices On Sydney and Melbourne dwelling prices, Davison says higher interest rates and mortgage rates will "subdue the extent of price growth, particularly beyond the two-year time frame". Shane Oliver says it is hard to see how the price growth of Sydney and Melbourne can continue. "While prices will not crash, there will be softer capital growth and maybe even some decline during the next couple of years," he says. The most competitive variable mortgage interest rates sit between 3 per cent and 4 per cent. Actuaries at Rice Warner say interest rates are widely expected to rise over the next few years following the recovery of the American economy and the interest rate hikes in the US. "As Australian investors are predominantly tied to variable rate loans, any increase in rates would quickly feed into the cost of servicing mortgages," the actuaries say. \nDiversification the key Deloitte Access Economics thinks Australian interest rates will not start rising until 2018 - but they will rise. And, of course, banks and other lenders have already been increasing their mortgage interest rates, especially to investors. "Housing prices are dangerously dumb," says Deloitte economist Chris Richardson. And more Sydneysiders, in particular, could struggle to service their mortgages. Philpot says it is impossible to predict investment returns with any certainty, especially over short periods. He says it's important to remember the only free lunch in investing is diversification. "As long as you don't get too caught up in trying to move your portfolio around because what happens is that you buy-in when markets have done well and sell at the lows and you destroy capital," he says. "If you stick to that longer-term asset allocation - you generally don't go too far wrong," Philpot says.