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Housing: ‘Direction of inflation will really determine the Fed’s actions,’ strategist says

Principal Global Head of Real Estate Research and Strategy Indy Karlekar joins Yahoo Finance Live to discuss investing in real estate amid economic turbulence, Fed policy, and the outlook for the real estate market.

Video Transcript



RACHELLE AKUFFO: Reports this week have shown the US housing slump stretched into a fifth month as home prices abroad slide lower domestically as well as abroad. Now, despite rising interest rates, is now a good time to invest in real estate? Here to weigh in on that and the outlook for real estate investments is Principal Asset Management's Global Head of Research and Portfolio Strategy Indraneel Karlekar.

Thank you for joining me, Indy. So I want to ask you, a lot of people-- there's a lot of noise out there and a lot of signals to watch. How are you sorting through this and determining what we should be paying attention to when trying to invest in this space?

INDY KARLEKAR: Yeah, good morning, Rachelle. As you said, there's a lot of noise out in the market. And we believe that noise will continue for the foreseeable future. And the rationale is pretty simple, really, if you think about what's happening in the US economy. We're seeing two forces at work. One is inflation, and the other is the Federal Reserve working hard to push that inflation level down.

And so what we are telling investors is really focus on those two signals very, very clearly because the direction of inflation will really determine the direction of the Fed's actions. And unfortunately, it seems that until the Fed-- at least from our perspective, the Fed is likely to stay resolute in its wording and its language until it sees very clear signs that inflation is on the way down or feels comfortable that inflation is where it needs to be. And until that happens, we think the capital markets, and real estate markets for that matter, are going to remain somewhat volatile, somewhat turbulent.

So what we are recommending investors is really stay focused on cash flows that are resilient, that can withstand the spirit of turbulence that we expect over the next 6 to 12 months, but also be prepared to pivot to opportunities because when there's dislocation, there is also opportunity. So it's really building a resilient and nimble portfolio in real estate that focuses on the full array of opportunities that is available to a real estate investor, including, of course-- including, of course, the residential sector.

But also be prepared to invest more opportunistically, more nimbly in the public quadrants of real estate, for example, REITs. When they dislocate, they might offer some interesting opportunities. So big picture, we're telling investors is be defensive, recognizing that we're going to enter a period of uncertainty, potential recession, but be prepared to be nimble and pivot when the opportunities do arise.

RACHELLE AKUFFO: So then looking within REITs then, what are some of the key themes to keep an eye on when really determining when to enter the market and how to enter it?

INDY KARLEKAR: Yeah, that's the million-dollar question, Rachelle. I think when we look at REITs, we look more holistically from the perspective of a real estate owner. And ultimately, REITs do offer a different form of ownership to commercial real estate, albeit in the public side.

And so we look for similar things underlying REITs. How is their earnings? What, say, are cash flow opportunity? How resilient are these cash flows? So when we're looking at the opportunity for REITs, in REITs we are looking at which REIT stocks are more resilient in terms of cash flows, which REIT stocks are able to generate stronger earnings despite the potential uncertainty. So when we're looking at REITs, we're looking at these two underlying drivers.

But more importantly, we are also looking at when the timing may occur, when the timing may become more favorable in terms of the, quote unquote, "Fed pivot," the great Fed pivot. Now the challenge is, of course, it's very hard to precisely determine when the Fed does stop its interest rate tightening cycle. But we believe that time will come when it feels that the inflation outlook has improved materially.

And when that timing does occur, the REIT market, the US listed REIT market, will become a really interesting spot to play. And so-- so we're looking for a couple of things. We're looking for the earnings outlook. We're looking for REITs that trough structurally resilient cash flows. And of course, we're looking for when there are clear signs that the Fed has done, at least for the time being, with its interest rate tightening policies.

RACHELLE AKUFFO: And how are you seeing some of these investment strategies differ depending on age demographic?

INDY KARLEKAR: That's a great question. We believe that the US, like any other developed market, is going through a profound change in its demographic outlook. We're aging as a society. We're getting grayer. And that's leading to a whole host of different opportunities, particularly in demographically-driven real estate strategies.

So I'll pick on a couple. For example, if you look at the residential market in the US, it's a vast market. But for right or wrong reasons, people have typically-- or investors, analysts have typically focused on this owner-occupied residential sector.

We think if you step out of the owner-occupied residential sector, there are significant opportunities up and down the demographic scale to invest in it, whether it's single-family rentals, whether it's manufactured homes, whether it's age-restricted housing, whether it's senior living, whether it's assisted living, or it's scale living. There's a whole gamut of demographic-related opportunities to invest in the US residential sector. It's not only about single-family, owner-occupied homes. And that's just one example of how you can play the demographic shift that's occurring in the US.

But there's also other ways of playing the demographic shifts in the US, and the other is through, for example, the retail market. The retail patterns are changing. 10 years ago, e-commerce as a percentage of retail sales was growing but it was pretty small. You look fast-forward now, e-commerce is about 15%, 16%, 17% of retail sales. And a lot of that is being driven by the shift in the US demographics.

The millennials, the Generation Z, the younger generation much more liable to purchase and use e-commerce on their smartphones or on their tablets, and that's changing the way the US retail industry is evolving. Bricks and mortar has always been important for retailers, but so is clicks and mortars. It's become really important to have that holistic experience for retailers. So that's another example of how the shifting demographics in the US is actually shifting the way we shop, and that opens up opportunities as a real estate investor. Should we be invested only in bricks and mortar or should you also invest in companies that give you clicks and mortars?

RACHELLE AKUFFO: That's fascinating. I love that clicks and mortars, definitely not something we hear talked about enough. There's so much focus on those single-family homes, not as much focus on demographics. Great stuff there. Principal Global Head of Research and Portfolio Strategies. Indraneel Karlekar, thank you so much.