Housing Inflation Misunderstood
A key category in the measure of inflation is housing inflation. In fact, housing is the largest expense for the average US household and is more than a third of the CPI calculation by weight. Typically, housing costs tended to be stable, but Covid-19 changed all that as housing costs skyrocketed. During the Covid years rent grew as much as 15% annually. The above chart represents the result of the massive Fiscal Policy followed by the Monetary policy of raising rates.
But in recent years, measuring housing costs as a part of predicting inflation has come under scrutiny. As recently as October of 2022 the US Bureau of Labor Statistics has studied and written about the important differences in measuring rent inflation, particularly when measuring new tenant rent versus all renters. Interestingly a report that didn’t get much fanfare.
Their report “Disentangling Rent Index Differences” found that accurate inflation forecasting would be critically dependent on current rent inflation measurement. To their dismay, they found that rent indices differed quite a bit. They found that in 2022 the inflation rates using the Zillow Observed Rent Index and the Marginal Rent Index were as high as 15% and 12% while the BLS CPI calculation for rent inflation was mere 5%.
The study goes on to disentangle the BLS data into new tenants versus all tenants and tries to confirm that the difference in rent inflation is indeed due to this distinction rather than other factors including structure and quality. The BLS data was able to define a “new-tenant” as only leases of those “recently” moved in. Different than “all tenants” whether they had moved in recently or not. It would be safe to say that many factors affect rental levels and the change or lack thereof in rent prices. That said, what rent index or calculation should be used in the CPI calculation given now we see such a large difference in the results? Hard to say, but it was found that new tenant rent inflation led the BLS rent inflation by 4 quarters. This finding isn’t too far-fetched when one understands that leases are not resigned for at least a year and the BLS only surveys units twice a year. Additionally, the impact of Covid surely affected the rental rates of those that were “moving-in” during that volatile time. Though that does beg the question of what would be the “rent” of those that “moved-out” at home lease end or not (ie those that abandoned their lease). That said, understanding what would be normalized inflation, let alone housing inflation, and then fashioning a FED response seems difficult at best. I might now have more acceptance of Janet Yellen’s response that “inflation was transitory”, maybe she was right but lack of early FED action still makes it unclear. A chicken and egg question?
Additionally, we need to look at the Owners’ Equivalent Rent which highlights what someone might pay in substitute rent for their currently owned house. This is even more interesting considering that the duration of low mortgage rates leading to low and fixed rate mortgages for many owners, this OER will not rise as people stay in their homes and demand a “lower” rent to become a “new tenant”. It’s hard to argue that high housing inflation wasn’t “temporary” and going forward housing inflation won’t continue to come down given the recent trend.
Revisiting our first chart, it in fact shows that currently housing is the largest component of inflation while everything else is in fact stabilizing or in disinflation (energy). We could even defend that there is more decline to come as FED policy has fully yet to take effect and despite the FED stating that Recession now is unlikely, we should still expect continued reduction in economic growth and thus lower inflation. Our takeaway, which is still a little disconcerting, is the policy moves taken by the powers that be on forecasted inflation is only as good as the data. Should we worry that at best, for such critical inflation data, policy and action we are still guessing? Garbage in and garbage out takes on new meaning…