Inflation, Rent, and Owners’ Equivalent Rent

Is the sky falling?

As we saw yesterday, consumer price index releases from the BLS continue to pile on evidence supporting the theory that the current pressures are transitory. Used cars and airplane tickets have passed their peak and are now on their way back down. Beyond supply chains starting to straighten out, perhaps another factor that plays into this is the country as a whole sitting in a liminal state between a fully opened economy and a closed-due-to-pandemic economy. So, instead of everyone rushing to buy a plane ticket or rent a car, like they were in early June, some people may be holding back to protect themselves from the virus. This moderates the demand side of the imbalance in the sectors that were or are facing bottlenecks—and probably dampens whatever future impacts we might expect once we are finally out of the woods.

So with the used car and the airplane ticket falling out of favor as a scapegoat for skeptics of expansionary policy, a new foil has been found by some in rents and owners’ equivalent rents (OER). A month ago, Politico published a piece stating that:

“Housing costs could eventually boost inflation by as much as 2 percentage points by the end of next year, though the effects could be felt sooner, according to a forecast from Fannie Mae.”

and

“…housing-driven inflation could also start to rise as higher rents slowly cycle into the official tracking of price increases, a process that may have been delayed because leases are traditionally annual.”

We are now two months into summer, the most common time for lease renewals. But the past two months, rent prices actually decelerated month-over-month, as shown on the yellow line below.

Month over month changes in the price level for rents and owners’ equivalent rents, with Core CPI.

Below are the year-over-year changes broken out by Census region, with homeowner costs on the left and rents on the right. The northeast is particularly interesting—basically sitting flat, under 1% year over year, for the past couple of months. In the west, OER has definitely gone up, and in the midwest it’s almost back to pre-pandemic levels—though the midwest did not collapse anywhere near the way that the west did. The south, however, appears to be going through a normal cycle, not unlike what happened between mid-2018 and mid-2019.

Price change in OER and Rent, year over year, by Census region.

Rents collapsed 16 months ago, especially in the high-cost west and northeast, and are still just kind of hovering around where the landed. The midwest has seen a slight uptick which is probably explainable by looking at a couple of big cities in the area, but if this is all the increase we have from two of the busiest lease renewal months of the year, it does not really bode well for the falling sky theory.

Month over month changes in the price level for rents by Census region.

Above, the month-over-month changes in rent prices are pretty volatile, but it’s easy enough to tell that there isn’t anything crazy going on, except perhaps for in the midwest as we already noted. It is notable that the change in NE rents went slightly below zero this month, but that does not exactly help the story that rents are getting ready to skyrocket.

The most interesting piece of this puzzle is the story that OER tracks consistently with a home price index, like the S&P/Case-Shiller index. The theory goes that if you take the the home price index and shift it 18 months ahead (or shift OER 18 months back) then you get this nice correlation of price changes, meaning that OER lags behind prices by a year and a half. So let’s take a look:

Case-Shiller home price index with OER, year over year price changes, with 18 month shift. The scales have been adjusted and the labels are correct.

Now to be fair there is definitely some shared movement between these lines. That makes sense. One of them tracks the prices of houses, and the other one tracks how much people pay each month for their houses. Of course they’re related. But the question we are looking to answer is whether we have any indication that we will get significant, sustained increases in OER that blow up some of the economic gains we’ve seen this year. That seems much less clear from this chart.

First of all, the scale of the dip in OER from April 2020 to April 2021 does not match the scale of the price dip. But last time the price index tanked—in 2007—the scale of the price dip was significantly larger than the scale of the OER dip. But in the most recent period of relatively stable OER price growth (2014 to 2020), the price index is all over the place. We also saw pretty consistent home price growth from 1992 to 2007 (a few small bumps in the road), but during that period OER rose and fell somewhat significantly several times.

Scatterplot of changes in the home price index vs. the OER. R^2 = 0.361.

Again, when we take a look at a scatterplot, we can see that there is clearly some directional correlation between these numbers. Just from looking at the shape of the data (see the lower left, for example—this is the only period where OER goes negative, at rock bottom of the housing crisis) we can see that the figures trend cyclically with each other. But the scale or transformation effect they have on one another varies widely. Sometimes they appear to move independently, sometimes one moves more pronounced than the other, and sometimes less.

Anyways, my feeling is that price growth in OER is probably more connected to geography and work-from-home driven moves this cycle. We have evidence already that the effects so far are very different by region. And much of the home buying, apparently, has been driven by an ability to work from home. It seems like there are too many new factors and not enough correlation to make a strong prediction on way or the other. But we’ll see.