Worried about the next bear market? Real estate may be your best investment. Really.

Mark Hulbert | Special to USA TODAY

Show Caption Hide Caption This is the hottest housing market in the U.S. Prices are up 12.7%.

Real estate may be one of your best investments during the next bear market for stocks.

And by real estate, I mean your home or other residential properties.

That’s important to remember, not just because we often overlook our house when focusing on our holdings, but also because the recent volatility in markets has many investors on edge.

Most investors harbor a deep mistrust of real estate, given their experiences during the financial crisis and bear market a decade ago. During the big downturn from late 2007 to early 2009, the Standard & Poor’s 500 stock index fell 57%, and residential real estate — as measured by the S&P CoreLogic Case-Shiller national home price index — lost 18%. And since most people with property have a mortgage, actual losses from real estate during that downturn often were much greater.

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Yet real estate’s performance during the Great Recession is the exception rather than the rule. Consider the 19 bear markets since 1952 other than the one between 2007 and 2009: The Case-Shiller index shows increases in all but one, and in the one in which it fell, it declined by just 0.4%. Even including the Great Recession, Case-Shiller shows an annualized average increase of 4.6% for all stock bear markets since 1950.

To be sure, since long-term Treasury bonds did even better than Case-Shiller in these 20 stock bear markets, gaining an average of 6.2% annualized, you might wonder if bonds are an even better hedge against bear markets. Today’s low interest rates make it unlikely Treasury bonds will perform as well in the next bear.

This especially will be the case if the next big downturn is accompanied by a flare-up of inflation. That’s because inflation is bad for bonds and, at least historically, good for real estate.

Gray Cardiff, editor of the Sound Advice newsletter, has another reason to believe it is important to shift some of your holdings away from stocks into real estate. Cardiff’s is one of the few newsletters whose model portfolios have beaten the market over the long term, according to the Hulbert Financial Digest’s performance monitoring. Over the last 20 years, for example, his newsletter’s model portfolio has beaten the dividend-adjusted Standard & Poor’s 500 by 1.3 annualized percentage points.

Cardiff points out that, relative to stocks, real estate is undervalued. In fact, based on data back to 1896, he says that, when compared with stocks, real estate has rarely been cheaper.

The last time the ratio was higher than today was during the Internet bubble. In the bear market that accompanied the bursting of that bubble, during which the S&P 500 lost nearly 50%, the Case-Shiller home price index rose more than 20%.

Unfortunately, there’s no easy or straightforward way for you to invest in residential real estate as an asset class. Most of us invest in real estate by owning our home or another specific property, and there are myriad factors affecting an individual property’s value that are independent of how the real estate category performs nationwide.

Cardiff recommends real estate investment trusts (REITs) as a way of gaining real estate exposure. However, he says you have to be on our guard against REITs that are profitable today only because interest rates are so low.

Three REITs that his analysis suggests will be profitable even if rates rise markedly from current levels are Hersha Hospitality Trust (HT); RLJ Lodging Trust (RLJ) and Third Avenue Real Estate Value Investor (TVRVX).

Mark Hulbert, founder of the Hulbert Financial Digest, has been tracking investment advisers' performances for four decades. For more information, email him at mark@hulbertratings.com or go to www.hulbertratings.com.

