by The Federal Reserve may have a housing problem. At the very least, you have a real estate conundrum.
Headline inflation has decreased substantially over the past year. But housing has proven to be a tenacious and surprising exception. Housing costs rose 6 percent in January from a year ago and rose more rapidly on a monthly basis than in December, according to the Labor Department. That acceleration was a major reason for the rebound in overall consumer prices last month.
The persistence of housing inflation poses a problem for Federal Reserve officials as they consider when to cut interest rates. Housing is by far the largest monthly expense for most families, which means it weighs heavily in inflation calculations. Unless housing costs fall, it will be difficult for inflation as a whole to sustainably return to the central bank’s target of 2 percent.
“If you want to know where inflation is going, you need to know where housing inflation is going,” said Mark Franceski, managing director of Zelman & Associates, a real estate research firm. Housing inflation, he added, “is not slowing at the rate we expected or that anyone expected.”
Those expectations were based on private sector data from real estate websites like Zillow and Apartment List and other private companies that show rents have barely risen recently and have been falling outright in some markets.
For home buyers, the combination of rising prices and high interest rates has made housing increasingly unaffordable. On the other hand, many existing homeowners have been partially protected from rising prices because they have fixed-rate mortgages with payments that don’t change from month to month.
However, house prices and mortgage rates do not appear directly in inflation data. This is because buying a home is an investment, not just a consumer purchase like food. Instead, inflation data is based on rents. And with private data showing rents moderating, economists have been expecting the slowdown to show up in government data as well.
Federal Reserve officials largely discounted housing inflation for much of last year, believing that official data had simply been slow to pick up the cooling trend evident in private data. Instead, they focused on measures that exclude housing, an approach they believed better reflected underlying trends.
But as the divergence has persisted, some economists inside and outside the Federal Reserve have begun to question those assumptions. Goldman Sachs economists recently raised their housing inflation forecast for this year, citing rising single-family home rents.
“There is clearly something going on 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 watching?’ I would say, ‘I’m looking at housing because that’s what’s still strange.'”
Delayed data
The stubborn nature of housing inflation is not a total mystery. Economists knew it would take time for the rent moderation seen in private sector data to trickle into the Labor Department’s official Consumer Price Index.
There are two reasons for this delay. The first is technical: The government data is based on a monthly survey of thousands of rental units. However, a given unit is only surveyed once every six months. So if an apartment is surveyed in January and the rent increases in February, that increase won’t appear in the data until the apartment is surveyed again in July. That causes government data to lag behind conditions, especially during periods of rapid change.
The second reason is conceptual. Most private indices include rentals only when they get new tenants. But the government aims to capture housing costs for all tenants. Because most leases last a year or more, and because those who renew their leases often get a discount relative to people who rent on the open market, government data will generally adjust more gradually than private indexes.
Public and private data should eventually converge. But it’s unclear how long that process will take. The rapid increase in rents in 2021 and 2022, for example, led many people to stay put rather than enter the red-hot rental market. That, among other factors, may have made it take longer than usual for market rents to filter into government data.
There are signs that a slowdown is underway. Rents have risen at an annual rate of less than 5 percent over the past three months, down from a peak near 10 percent in 2022. Private data sources disagree on how much inflation still needs to decline. rents, but they agree that the trend should continue.
“For the most part, they’re all saying the same thing, which is that rent inflation has moderated significantly,” said Laura Rosner-Warburton, senior economist at MacroPolicy Perspectives, an economic research firm.
Houses versus apartments
While rent inflation may finally be moderating, the government’s measure of costs to homeowners has not followed suit; in fact, it accelerated in the last month’s data. And because more Americans own than rent, owner-occupied homes dominate the housing component of the Consumer Price Index.
Expenses that most people associate with home ownership (mortgage payments, homeowner’s insurance, maintenance and repairs) are not directly included in inflation measures.
Instead, the government measures housing inflation for landlords by assessing how much it would cost to rent a similar home, a concept known as landlord equivalent rent. (The idea is that this measures the value of the “service” of providing a home, as opposed to the investment gains from owning it.)
Rent and ownership measures typically go together because they are based on the same underlying data: the study of thousands of rental units. But in calculating ownership figures, the Labor Department gives greater weight to homes that are comparable to owner-occupied units. That means that if different types of housing behave differently, the two measures can diverge.
That could be what’s happening now, some economists say. The apartment construction boom in recent years has helped drive down rents in many cities. However, single-family homes remain in short supply just as millions of millennials are reaching the stage where they want more space. This is driving up the cost of homes for both buyers and renters. And because most homeowners live in single-family homes, single-family units play a huge role in calculating homeowners’ equivalent rent.
“There’s more pressure behind single-family homes, and there’s a very good argument for why that heat will persist,” said Skylar Olsen, chief economist at Zillow.
A coincidence or something more?
Other economists doubt that the spike in inflation in January is the start of a longer-lasting trend. Single-family home rents have been outpacing apartment rents for some time now, but only recently has inflation for homeowners and renters diverged. That suggests the January data was a fluke, argued Omair Sharif, founder of Inflation Insights, an economic research firm.
“Month-to-month things in general can be hectic,” Sharif said. The good news from the report, he said, is that rental growth has finally started to cool, giving him more confidence that the long-awaited slowdown is emerging in official data.
However, that conclusion is far from certain. Before the pandemic, different parts of the housing market told generally consistent stories: Apartment rents rose at about the same rate as single-family home rents, for example.
But the pandemic destroyed that balance, driving rents up in some places and down in others, altering the relationships between the different measures. That makes it difficult to be confident about when official data will cool, or to what extent, which could make the Federal Reserve more cautious in considering cutting interest rates, said Sarah House, senior economist at Wells Fargo.
“Right now, they’re still assuming there’s still a lot of disinflation in the works, but that will keep them cautious in their optimism,” he said, referring to Federal Reserve officials. “They have to think about where the shelter actually ends and how long it takes to get there.”
Audio produced by Tally Abecassis.
