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Follow the Rent Data or the Housing Data?

A look at Shelter Inflation ahead of CPI data

The US CPI is set to be released on Wednesday, May 15. The consensus is for the readings to come in lower than last month.

  • Headline CPI for April is expected to come in at 3.4% YoY compared to 3.5% in March

  • Core CPI for April is expected to come in at 3.6% YoY compared to 3.8% in March

One of the more troubling data points in the CPI has been shelter inflation - mainly rent. Now, we know that Shelter inflation makes up ~36% of the CPI data, so that remains a substantial data point.

We thought it would be good to talk about shelter inflation at this stage and publish our full Weekly Dashboard tomorrow ahead of CPI data.

Background on Shelter Inflation

Here’s a breakdown and as you can see the largest portion remains OER (Owners’ Equivalent Rent).

The BLS says they determine OER with the survey question: “If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?”

Further, the following question is asked of consumers who rent their primary residence, are the basis of the weight for rent: “What is the rental charge to your [household] for this unit including any extra charges for garage and parking facilities? Do not include direct payments by local, state or federal agencies. What period of time does this cover?”

From the responses to these questions, the CPI program estimates the total shelter cost to all consumers living in each index area of the urban United States, which is then used to weight the OER index. Note that these responses are not used in estimating price change for the shelter categories, only the weight.

You can see it’s not the most scientific approach and it’s well-known that the OER & Rent of Primary residence tends to lag realtime rent data.

This lag was previously thought to be 6 months, but now we’re seeing some discuss a lag of even 12-14 months.

Real-time Rent Data

This morning I was looking at last month’s rent data to see where we stand. The headline from Zillow’s monthly publication was alarming.

“Renters Need to Make $80,000 to Comfortably Afford the Typical U.S. Rental - Zillow”

This is definitely not cheap and raises some alarm bells.

Looking at the rest of the data, we’re seeing a mixed picture.

Zillow’s Observed Rent Index (ZORI) shows rents flattening out and in fact increasing on a YoY basis. The monthly change has been minor.

An important point to note though is that the increase in Single-family rental is higher than that of overall homes and multi-family, which obviously makes sense. However, the data matters because recent changes to OER methodology puts more weight on Single-family rental units. So this may drive OER higher, or at least prevent deceleration.

On the flip side though, we see other multiple data points that actually point to lower rents.

The Apartment List National Rent Index has shown a decline in YoY rent by -0.8%, although if you look at the trajectory below, it’s not altogether comforting. There is a subtle increase from Q3, 2023.

On a month-on-month, basis the data has been showing an increase from Feb 2024 onwards.

Finally, here’s a chart from Morgan Stanley that shows the New Tenant Rent Index (NTRR) from BLS matched to the rental index from CoStar which both seem to be trending downwards, quite significantly. Morgan Stanley expects rents to start decelerating in the second half of 2024 based on the data below.

MacroVisor View

We’ve been looking at rent inflation on the basis of the home price index data. We introduced this back in Nov 2022, and our conclusion was that Shelter CPI would peak in Aug 2023.

The data has actually worked out quite well. In fact, CPI Shelter Inflation peaked ahead of Aug 2023, and has been decelerating on a YoY basis ever since. So if we look at the updated data now, what we see is a kink in the Home Price Indices and that brings us back to worrying about shelter inflation.

If the relationship that we’ve been seeing holds, we’re likely to see shelter inflation start to inflect higher in the coming months, quite contrary to what the rent data is telling us. A rough estimation seems to put us in June - July 2024 for that phenomenon to kick in.

Why does housing data matter? It’s because of the way the OER survey is taken.

If you read the survey questions again under the background survey, the first one asks “how much do you think you could rent for”. We all know that rent is a function of home price or vice versa.

So when home prices are higher, people automatically think about charging higher rent:

  1. because you don’t want to change your rental yield (rent/home price)

  2. fewer people can afford to buy a home, so they rent creating more demand in the rental market (which is exactly what we’re seeing play out in the US)

Finally, there is also the issue of immigration. From the limited research that I have done (so don’t quote me on this), there could be rental pressures coming in from the higher levels of immigrants entering the US because they cannot buy homes.

Closing Thoughts

Shelter Inflation is important and it has surprised us for a while. There is a great argument for rents to go lower in the second half of the year, as Morgan Stanley has pointed out, and as the rent indices are showing us.

On the other hand, the home price indices don’t exactly paint a pretty picture. Mortgage rates remaining higher-for-longer, courtesy of the Fed holding steadfast, could see home prices start to fall again which could ultimately smooth out shelter inflation. For now, it continues to remain a concern for me and a data point that I keep watching closely.

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