Rents are falling. So why isn’t that showing up in the inflation data?
The Federal Reserve may have a housing problem. At the very least, it has a housing conundrum.
Overall inflation has declined significantly over the past year. But housing has proven to be a persistent – and surprising – exception. According to the Ministry of Labor, shelter costs in January were 6 percent higher than a year earlier and were rising faster on a monthly basis than in December. That acceleration was a major reason for the increase in overall consumer prices last month.
Persistent housing inflation poses a problem for Fed officials as they consider when to roll back rates. Housing is by far the largest monthly expense for most families, meaning it weighs heavily on inflation calculations. Unless house prices decline, it will be difficult for inflation as a whole to return sustainably to the central bank’s target of 2 percent.
“If you want to know where inflation is going, you have to know where housing inflation is going,” said Mark Franceski, president of Zelman & Associates, a housing research firm. Housing inflation, he added, “is not slowing at the pace that we expected or that anyone else expected.”
These expectations were based on private sector data from real estate websites such as Zillow and Apartment List and other private companies, which shows that rents have barely risen recently and have even fallen outright in some markets.
For homebuyers, the combination of rising prices and high interest rates has made housing increasingly unaffordable. In contrast, many existing homeowners are partially insulated from rising prices because they have fixed-rate mortgages where payments do not change from month to month.
However, house prices and mortgage rates are not directly reflected in the inflation data. That’s because buying a home is an investment, not just a consumer purchase like groceries. Instead, the inflation data is based on rental prices. And with private data showing rents moderating, economists have looked for the slowdown to show up in government data as well.
Federal Reserve officials have largely dismissed housing inflation for much of the past year, believing that the official numbers were simply slow to catch up with the cooling trend emerging from the private data. Instead, they focused on shelter-in-place measures, an approach they said better reflected underlying trends.
But as the differences persist, some economists inside and outside the Fed have begun to question these assumptions. Economists at Goldman Sachs recently raised their forecast for housing inflation this year, citing rising rents for single-family homes.
“Clearly something is happening that we don’t understand yet,” Austan Goolsbee, president of the Federal Reserve Bank of Chicago, said in a recent interview. “They ask me, ‘What are you looking at?’ I would say, ‘I’m looking at housing, because that’s still the strange thing.’”
Lagging data
The persistent nature of housing inflation is not a total mystery. Economists knew it would take some time for the moderation in rents reflected in the private sector data to make its way into the Labor Department’s official consumer price index.
There are two reasons for that delay. The first is of a technical nature: the government data is based on a monthly survey of thousands of rental properties. However, a given unit is only surveyed once every six months. So if an apartment is inspected in January and the rent goes up in February, that increase won’t show up in the data until the apartment is inspected again in July. This causes government data to lag behind conditions, especially during periods of rapid change.
The second reason is conceptual. Most private indexes only include rental properties when new tenants are added. But the government wants to absorb housing costs for all tenants. Because most leases last a year or more, and because those who renew their leases often receive a discount compared to those renting on the open market, government data will generally adjust more gradually than private indexes.
Public and private data should eventually converge. But it is not clear how long that process will take. For example, the rapid increase in rental prices in 2021 and 2022 caused many people to stay put rather than enter the red-hot rental market. This may, among other things, have meant that it took longer than normal for market rents to filter through to government data.
There are signs that a slowdown is coming. Rents have risen less than 5 percent annually over the past three months, after peaking at nearly 10 percent in 2022. Private data sources disagree on how much more rental inflation needs to decline, but they agree the trend should Get on.
“For the most part, they’re all saying the same thing, which is that rental inflation has come down significantly,” said Laura Rosner-Warburton, a senior economist at MacroPolicy Perspectives, an economic research firm.
Houses versus apartments
While rental inflation may finally be moderating, the government has not tracked costs for homeowners; according to last month’s data, it has actually accelerated. And because more Americans own their homes than rent, owner-occupied homes dominate the shelter component of the consumer price index.
The costs that most people associate with homeownership – mortgage payments, homeowners insurance, maintenance and repairs – are not directly included in the inflation measures.
Instead, the government measures housing inflation for owners by assessing how much it would cost to rent a similar home, a concept known as owners’ equivalent rent. (The idea is that this measures the value of the ‘service’ associated with offering a home, as opposed to the investment gain from owning it.)
The rental and ownership metrics tend to move together because they are based on the same underlying data: the survey of thousands of rental units. But to calculate ownership figures, the Ministry of Labor gives greater weight to homes that are comparable to owner-occupied homes. This means that if different housing types behave differently, the two measures may differ.
That could be what’s happening now, some economists say. The apartment construction boom of recent years has helped drive down rental prices in many cities. However, single-family homes remain scarce just as millions of millennials are reaching the stage where they want more space. That drives up house prices for both buyers and renters. And because most homeowners live in single-family homes, single-family homes play an outsized role in calculating the owners’ equivalent rent.
“There is more heat behind single-family homes, and there are very good arguments for why that heat will continue,” said Skylar Olsen, chief economist at Zillow.
A fluke, or something more?
Other economists doubt whether January’s rise in inflation is the start of a more sustainable trend. Rents for single-family homes have been higher than apartments for some time, but only recently has inflation for owners and renters diverged. That suggests the January data was a fluke, argued Omair Sharif, founder of Inflation Insights, an economic research firm.
“The month-to-month things in general can be choppy,” Mr. Sharif said. The good news in the report, he says, is that rental growth is finally starting to cool, making him more confident that the long-awaited slowdown will be reflected in the official figures.
However, that conclusion is far from certain. Before the pandemic, different parts of the housing market told generally consistent stories: Apartment rents, for example, were rising at about the same pace as single-family homes.
But the pandemic has destroyed that balance, causing rents to rise in some places and fall in others, disrupting the relationships between the different measures. That makes it difficult to have confidence in when official data will cool, or to what extent — which could make the Fed more cautious as it considers cutting rates, said Sarah House, a senior economist at Wells Fargo.
“Right now, they’re still assuming there’s still a lot of disinflation in the pipeline, but it will keep them wary of their optimism,” she said, referring to Fed officials. “They need to think about where the shelter will actually end up and how long it will take to get there.”