The Federal Reserve may have a housing problem. At least there is a case mystery.
Overall inflation fell significantly last year. But housing has proven to be a stubborn – and surprising – exception. According to the Labor Department, housing costs rose 6 percent in January compared to a year ago, rising faster each month than in December. This acceleration was a big reason for the increase in overall consumer prices last month.
Persistent housing inflation poses a problem for Fed officials as they consider when to cut interest rates. Housing is by far the largest monthly expense for most families, meaning it weighs heavily on inflation calculations. Unless property prices fall, overall inflation will find it difficult to sustainably return to the central bank’s 2 percent target.
“If you want to know where inflation is going, you have to know where housing inflation is going,” said Mark Franceski, managing director at Zelman & Associates, a real estate research firm. Housing inflation, he added, “is not slowing down at the rate we expected or 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 increased recently and have even fallen in some markets.
For home buyers, the combination of rising prices and high interest rates has made housing increasingly unaffordable. Many existing homeowners, however, have been spared from rising prices in part because they have fixed-rate mortgages whose payments don’t change from month to month.
However, home prices and mortgage rates do not appear directly in the inflation data. Because buying a home is an investment and not just a consumer purchase like groceries. Instead, the inflation data is based on rents. And with private data showing a slowdown in rents, economists have expected the slowdown to be reflected in government data as well.
Federal Reserve officials largely dismissed housing inflation last year, believing official data had simply been slow to pick up on the cooling trend seen in private data. Instead, they focused on policies that exclude shelters, an approach they said better reflected underlying trends.
But as the divergence continues, 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.
“There is clearly something happening that we don’t yet understand,” 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 watching housing because it’s still weird.'”
Trailing data
The stubborn nature of housing inflation is not a complete secret. Economists knew it would take some time for the moderation in rents seen in private sector data to make its way into the Labor Department’s official consumer price index.
There are two reasons for this delay. The first is technical: The government’s 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 will not show up in the data until the apartment is surveyed again in July. This causes government data to lag behind conditions, particularly during times of rapid change.
The second reason is conceptual. Most private indexes only consider rentals when they attract new tenants. However, the government wants to cover housing costs for all tenants. Because most leases last for a year or longer, and those who renew their leases often receive a discount compared to open market renters, government data will typically adjust more slowly than private indices.
Public and private data should eventually merge. However, it is not clear how long this process will take. The rapid rise in rents in 2021 and 2022, for example, led many people to stay put rather than jump into the red-hot rental market. This and other factors may have resulted in market rents taking longer than usual to be included in 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, after peaking at nearly 10 percent in 2022. Private data sources disagree about the extent to which rental inflation has yet to ease, but they agree that the trend should continue.
“Broadly speaking, they all say the same thing, which is that rental inflation has eased significantly,” said Laura Rosner-Warburton, senior economist at MacroPolicy Perspectives, an economic research firm.
Houses vs. apartments
While rental inflation may finally be easing, the government’s measurement of homeownership costs has not followed this trend; It actually accelerated in last month’s data. And because more Americans own homes than rent, condos dominate the housing component of the consumer price index.
The expenses most people associate with homeownership—mortgage payments, home insurance, maintenance and repairs—are not directly included in measures of inflation.
Instead, the government measures property inflation for owners by determining how much it would cost to rent a similar home. This concept is called owner equivalent rent. (The idea is that this measures the value of the “service” of providing a home, as opposed to the investment gains that come from owning a home.)
The rental and ownership measures typically move together because they are based on the same underlying data – the survey of thousands of rental units. However, when calculating ownership, the Department of Labor places greater emphasis on houses that are comparable to condominiums. This means that if different types of housing behave differently, the two measures may differ from each other.
That could happen now, some economists say. The housing construction boom has led to falling rents in many cities in recent years. However, single-family homes remain in short supply as millions of millennials reach the point where they want more space. This drives up the cost of homes for both buyers and renters. And since most homeowners live in single-family homes, single-family homes play an outsized role in determining owners’ rent.
“There’s more heat behind single-family homes, and there’s a very good case to be made as to why that heat will continue,” said Skylar Olsen, chief economist at Zillow.
A coincidence or something more?
Other economists doubt that January’s rise in inflation represents the start of a more sustainable trend. Rents for single-family homes have been exceeding rents for apartments for some time, but only recently have inflation rates for owners and renters diverged. That suggests the January data was a fluke, argued Omair Sharif, founder of Inflation Insights, an economic research firm.
“Monthly data in general can be choppy,” Mr Sharif said. The good news in the report, he said, is that rental growth has finally started to cool, making him more confident that the long-awaited slowdown is starting to show in the official data.
However, this conclusion is far from certain. Before the pandemic, there were largely consistent figures in various parts of the housing market: rents for apartments rose at about the same rate as rents for single-family homes.
But the pandemic disrupted that balance, driving rents up in some places and down in others and disrupting the relationships between the different measures. That makes it difficult to say for sure when and by how much official data will cool – which could make the Fed more cautious as it considers rate cuts, said Sarah House, senior economist at Wells Fargo.
“Right now they still believe there is a lot of inflation relief in the pipeline, but that will temper their optimism,” she said, referring to Fed officials. “You have to think about where the property will actually end up and how long it will take to get there.”
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2024-02-26 19:30:21
www.nytimes.com
