The Best Inflation Hedge is Real Estate Investment Trusts

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According to a recent study, Real Estate Investment Trusts are one of the best ways for investors to protect themselves against inflation.

Inflation is something that investors under the age of 40 are not used to thinking about, because it has been going steadily downhill every since its peak in the early 1980s. Indeed, it doesn't seem to be a problem at all right now.

No COLAs -- Again

For the first time since government benefits such as Social Security were required to go up every year to match the rise of the Consumer Price Index, the government did not have to increase the checks in calendar year 2010.

And it's recently announced there will be no Cost Of Living Allowance (COLA) in 2011 either.

And President Obama is planning to freeze the salaries of federal workers (which also have COLAs) for the next two years as well, even though they've been frozen for the past two years already.

So why should investors worry?

If All US Dollars Circulated, We'd Be in Deep Trouble

For one thing, the United States has taken on an unprecedented amount of national debt. Plus, we have a huge trade deficit. There are huge numbers of dollars in bank deposits throughout the world.

If the central banks of Europe and Asia began spending their US dollars, that would send a blizzard of them into the international economy that would drive the value of the US dollar down to a horrifically low level.

If the US dollar were not the world's reserve currency, we'd now have a dramatically reduced standard of living.

Plus, we still have high levels of local government, corporate and personal debt.

Plus, food prices are rising fast. That's of greater immediate importance to ordinary people than the cost of, say, furniture.

Plus, there're a lot of reasons to believe energy costs, especially oil and natural gas, will go higher in the future, and that raises the cost of just about everything.

Because of the last national elections, come January the United States will have a government less eager to go into debt. However, today's news is that we're bailing out the European Union. I guess that's to thank them for forming the euro to displace the US dollar as the world's reserve currency. (I'm sure they're grateful.)

And the election didn't stop the Federal Reserve from creating about $1 trillion in new US dollars.

And there's already huge amounts of deficit spending already in motion that Republicans in Congress cannot stop.

Many Believe We're Headed Toward Inevitably High Inflation

So you have no guarantee that the low inflation of the last few decades will continue.

According to three French economists, however, in an article published in JOURNAL OF PORTFOLIO MANAGEMENT 35:4, 2009, Real Estate Investment Trusts can help investors hedge their portfolios against inflation.

The obvious common sense reason is that in times of high inflation, rents go up. Therefore, Real Estate Investment Trusts are in a position to profit.

The three economists are: Noel Amenc, Lionel Martellini and Volkmer Ziemann.

"Our results suggest that novel liability-hedging investment solutions, including commodities and real estate in addition to inflation-linked securities, can be designed to decrease the cost of inflation insurance for long-horizon investors."

REIT-Alternatives Have Disadvantages

However, commodities don't pay dividends, and their prices go down when the economy slows (they crashed later in the financial crisis).

Treasury Inflation Protections Securities (TIPS) bonds do pay out interest, but also do poorly when inflation is not high. For the first time in their history, TIPS (in the United States) are going DOWN in value.

Some REITs reduced their pay out cash dividends during the financial crisis in 2009 (switching to stock dividends instead), but many continued to do mail out full dividend checks, and some raised their dividends. So a diversified portfolio of REITs continues to send you checks no matter what the economy is doing, including times of high inflation. That makes them a terrific inflation hedge.

Next: When REITs pay stock dividends instead of the cash dividends shareholders are expecting to receive.

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