About the author: Susan Wachter is the Sussman professor of real estate and professor of finance at The Wharton School of the University of Pennsylvania and co-director of the Penn Institute for Urban Research. She is currently an advisory committee member of the Bureau of Economic Analysis of the Department of Commerce.
The U.S. Federal Reserve has been hoping for rent declines to slow inflation as measured by the consumer price index, where shelter costs make up more than 30% of the index. This hasn’t happened, and the evidence suggests that rents may now be on the increase. While housing has been a major channel for monetary policy to work to bring down inflation, this time around neither rent nor house-price declines are likely to assist.
Housing came to the Fed’s rescue in past episodes of inflation. Historically, the single-family, owner-occupied market has been the transmission vehicle for monetary policy. As the Fed tightened, higher mortgage rates dampened demand, causing declines in housing prices.
Not this time. Mortgage rates have doubled, but housing prices persist at all-time highs and affordability at 40-year lows. And while rents were falling, they are now moderating and, in many markets, rising. What happened?
The hope was that as pandemic bottlenecks resolved and housing supply increased, rents would decelerate. Rental supply in fact surged to more than 500,000 units a year in 2022 from a pre-Covid annual average of 300,000. Observers expected this would slow the pace of shelter costs, as accounted for in the CPI, with a lag. But markets have a mind of their own.
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Lags are due to the way shelter costs are measured in the CPI. Owners are asked to estimate their owners’ equivalent rent, what their home would rent for, at six-month intervals, and renters are asked for their contractual rent. In contrast, newly leased rental units reflect current market conditions, and existing rents take time to catch up. In this case, a helpful lagged effect of market rents on shelter costs was expected due to the supply surge. But that supply surge is currently being absorbed, while current rent and asset-price levels don’t justify new supply.
Rental prices had initially shot up starting in 2021 driven by economic stimulus, an overall recovery in aggregate demand, and the decision of many households and firms to move to the Sunbelt. Rents jumped by 10% in 2021-2022. This kicked off a wave of development. With the delivery of these new properties to market, vacancy increased and rent growth dropped below 2%.
With supply and vacancy growing and market rents decelerating, observers expected rents and OER rates to come down with a lag and lower the aggregate measured CPI inflation rate. The CPI data for May contained some good news: The overall rate of inflation decreased, in part due to declines in energy costs. Consumer prices increased 3.3% in May compared with a year earlier, slowing from April’s 3.4% reading. And for the first time since July 2022, the overall price level stayed flat from the month before. But shelter inflation increased at a rate of 5.4% on an annualized basis, more than offsetting the energy decline.
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Instead of continuing to decline, market measures of rent growth are now once again accelerating. Market rents are likely to move back to their long-term pattern of increasing faster than overall inflation. Since 1980, rents have increased at an average annual real rate of 1%. Rent increases vary by market, with rent softer in the Southeast and stronger in coastal markets (the Northeast and West), and by property type. Overall, recent rent-index numbers in the single-family rental market, which most closely mirrors the OER market, show rents increasing at about the same rate as the CPI year over year from April 2023 to April 2024, at 3.4%. Rent-growth rates had fallen to the 2%-3% range. The high-tier sector, which is disproportionately newly built, was in the lower part of that range. Rent growth fell less for low, low-middle, and high-middle market tiers.
But recently, all of these rent growth rates have trended upward. High interest rates and the Fed’s restrictive policies have decreased rental supply by pushing multifamily asset prices below construction costs. New multifamily housing starts fell back to about 300,000 units in 2024 and, with high housing prices discouraging moving homes, rent growth rates are reaccelerating.
In the owner-occupied space, the locked-in effect is part of the cause of low supply and persistently high prices, as high rates keep inventories low. Equally important are supply-side fundamentals. Construction costs are increasing faster than inflation due to scarcity of developable land, regulations, and labor costs. These cost increases also contribute to the lack of supply in the rental sector.
Advertisement – Scroll to Continue
The Fed can’t count on weak housing markets to dampen inflation, in the absence of a recession. But that doesn’t mean we’re stuck. Overall, it appears that inflation is once again falling. Economists widely expect the Fed to cut interest rates this year. That will help lower mortgage rates, and will make owner-occupied housing more affordable. Resulting inventory increases will help to meet demand.
Nonetheless, supply-side pressures will persist. Pent-up demand from millennials who have put off ownership will put upward pressure on prices as rates come down. Lower inflation and mortgage rates will help lower housing-finance costs, but we will also need to ease supply-side barriers to make housing more affordable.
Guest commentaries like this one are written by authors outside the Barron’s newsroom. They reflect the perspective and opinions of the authors. Submit commentary proposals and other feedback to ideas@barrons.com.
Housing Prices Are Stuck Until We Beat Inflation
About the author: Susan Wachter is the Sussman professor of real estate and professor of finance at The Wharton School of the University of Pennsylvania and co-director of the Penn Institute for Urban Research. She is currently an advisory committee member of the Bureau of Economic Analysis of the Department of Commerce.
The U.S. Federal Reserve has been hoping for rent declines to slow inflation as measured by the consumer price index, where shelter costs make up more than 30% of the index. This hasn’t happened, and the evidence suggests that rents may now be on the increase. While housing has been a major channel for monetary policy to work to bring down inflation, this time around neither rent nor house-price declines are likely to assist.
Housing came to the Fed’s rescue in past episodes of inflation. Historically, the single-family, owner-occupied market has been the transmission vehicle for monetary policy. As the Fed tightened, higher mortgage rates dampened demand, causing declines in housing prices.
Not this time. Mortgage rates have doubled, but housing prices persist at all-time highs and affordability at 40-year lows. And while rents were falling, they are now moderating and, in many markets, rising. What happened?
The hope was that as pandemic bottlenecks resolved and housing supply increased, rents would decelerate. Rental supply in fact surged to more than 500,000 units a year in 2022 from a pre-Covid annual average of 300,000. Observers expected this would slow the pace of shelter costs, as accounted for in the CPI, with a lag. But markets have a mind of their own.
Advertisement – Scroll to Continue
Lags are due to the way shelter costs are measured in the CPI. Owners are asked to estimate their owners’ equivalent rent, what their home would rent for, at six-month intervals, and renters are asked for their contractual rent. In contrast, newly leased rental units reflect current market conditions, and existing rents take time to catch up. In this case, a helpful lagged effect of market rents on shelter costs was expected due to the supply surge. But that supply surge is currently being absorbed, while current rent and asset-price levels don’t justify new supply.
Rental prices had initially shot up starting in 2021 driven by economic stimulus, an overall recovery in aggregate demand, and the decision of many households and firms to move to the Sunbelt. Rents jumped by 10% in 2021-2022. This kicked off a wave of development. With the delivery of these new properties to market, vacancy increased and rent growth dropped below 2%.
With supply and vacancy growing and market rents decelerating, observers expected rents and OER rates to come down with a lag and lower the aggregate measured CPI inflation rate. The CPI data for May contained some good news: The overall rate of inflation decreased, in part due to declines in energy costs. Consumer prices increased 3.3% in May compared with a year earlier, slowing from April’s 3.4% reading. And for the first time since July 2022, the overall price level stayed flat from the month before. But shelter inflation increased at a rate of 5.4% on an annualized basis, more than offsetting the energy decline.
Advertisement – Scroll to Continue
Instead of continuing to decline, market measures of rent growth are now once again accelerating. Market rents are likely to move back to their long-term pattern of increasing faster than overall inflation. Since 1980, rents have increased at an average annual real rate of 1%. Rent increases vary by market, with rent softer in the Southeast and stronger in coastal markets (the Northeast and West), and by property type. Overall, recent rent-index numbers in the single-family rental market, which most closely mirrors the OER market, show rents increasing at about the same rate as the CPI year over year from April 2023 to April 2024, at 3.4%. Rent-growth rates had fallen to the 2%-3% range. The high-tier sector, which is disproportionately newly built, was in the lower part of that range. Rent growth fell less for low, low-middle, and high-middle market tiers.
But recently, all of these rent growth rates have trended upward. High interest rates and the Fed’s restrictive policies have decreased rental supply by pushing multifamily asset prices below construction costs. New multifamily housing starts fell back to about 300,000 units in 2024 and, with high housing prices discouraging moving homes, rent growth rates are reaccelerating.
In the owner-occupied space, the locked-in effect is part of the cause of low supply and persistently high prices, as high rates keep inventories low. Equally important are supply-side fundamentals. Construction costs are increasing faster than inflation due to scarcity of developable land, regulations, and labor costs. These cost increases also contribute to the lack of supply in the rental sector.
Advertisement – Scroll to Continue
The Fed can’t count on weak housing markets to dampen inflation, in the absence of a recession. But that doesn’t mean we’re stuck. Overall, it appears that inflation is once again falling. Economists widely expect the Fed to cut interest rates this year. That will help lower mortgage rates, and will make owner-occupied housing more affordable. Resulting inventory increases will help to meet demand.
Nonetheless, supply-side pressures will persist. Pent-up demand from millennials who have put off ownership will put upward pressure on prices as rates come down. Lower inflation and mortgage rates will help lower housing-finance costs, but we will also need to ease supply-side barriers to make housing more affordable.
Guest commentaries like this one are written by authors outside the Barron’s newsroom. They reflect the perspective and opinions of the authors. Submit commentary proposals and other feedback to ideas@barrons.com.
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