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Inflation Protection

Investors have long recognized that investing in commercial real estate can provide a natural protection against inflation, as rents tend to increase when prices do. Other assets—notably commodities and Treasury inflation-protected securities (TIPS)—also provide good inflation protection, and even stocks can be an important part of a portfolio that protects investors against inflation shocks.

To understand the roles of listed equity REITs, commodities, TIPS, and other assets in protecting against inflation, NAREIT looked at historical periods when inflation was especially high and recorded whether or not the investment returns on each asset at least covered the inflation rate. As the graph below shows, the two assets providing the most dependable inflation protection since January 1978 have been commodities and equity REITs, with commodity returns exceeding inflation during 70.8 percent of high-inflation six-month periods and equity REITs close behind at 66.3 percent. Stocks and TIPS have provided somewhat weaker inflation protection, with stock returns exceeding inflation during 61.4 percent of high-inflation six-month periods and TIPS returns lower at 54.0 percent. The weakest inflation protector has been gold, with returns beating inflation during only 43.1 percent of high-inflation six-month periods.

While commodities have usually provided good inflation protection, commodity investors suffer badly when inflation is low, largely because energy and food prices are a major component of the price index. The graphs below compare asset returns during high-inflation and low-inflation periods. When inflation is high the best returns have come from commodities, with gold second and REITs third. During periods of low inflation or even falling prices, though, commodities and gold have typically provided returns close to zero or even negative. Unfortunately, investors can’t know beforehand whether inflation will be high or low—and, with commodities and gold, guessing wrong can be very costly. Listed equity REITs have historically provided strong returns when inflation is high AND (along with stocks) also when inflation is low, meaning that REIT investors aren’t hurt by guessing wrong.

As the first graph shows, an even better bet has been to blend the different assets into an inflation-protection portfolio. The graph shows a blend of 54.7 percent TIPS, 21.1 percent commodities, 13.9 percent listed REITs, 6.8 percent stocks, and 3.5 percent gold. The returns on that portfolio beat the inflation rate nearly three-quarters of the time when inflation was especially high.

The graph below summarizes different portfolios that achieved various levels of real return on average while minimizing portfolio volatility during high-inflation periods. A portfolio allocated 55.0 percent to commodities, 38.2 percent to listed equity REITs, 4.2 percent to TIPS, and 2.5 percent to stocks provided historical returns 12.39 percent greater than the inflation rate on average, and covered the inflation rate during 78.2 percent of high-inflation periods. In general, optimized inflation-protecting portfolios made heavy investments in commodities and REITs for higher real returns, and heavy investments in TIPS for stability.

The last graph summarizes optimized portfolios during low-inflation periods. When prices are stable, commodities play almost no role while TIPS and REITs form the bulk of optimally constructed portfolios.

For more information on using REIT investments for inflation protection please contact Brad Case, NAREIT’s Senior Vice President, Research & Industry Information, at