Simulating Real Estate in the Investment Portfolio: Model Uncertainty and Inflation Hedging

Real estate is regarded as an inflation hedge, however the autocorrelation of property return indices and the autocorrelation of changes in the CPI pose serious problems of inference. In this paper we address these problems in two ways. First, we use robust methods to test of changes in the relationship between property returns and inflation. Second, we perform simulations of sample investment portfolios using vector autoregressions to study the ability of commercial and residential housing to hedge inflation. Despite the relatively short sample period available, we find that property is likely to hedge inflation well.