Economy

Housing costs are rising, but is missing data a cooling trend?

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The Federal Reserve may have a housing problem. At the very least, there is a housing conundrum.

Overall inflation has declined significantly over the past year. But housing proved a stubborn – and surprising – exception. The cost of housing rose 6 percent in January from a year earlier, and rose faster on a monthly basis than in December, according to the Labor Department. This acceleration was one of the main reasons for the overall rise in consumer prices last month.

The persistence of housing inflation poses a problem for Fed officials, who are wondering when to cut interest rates. Housing is by far the largest monthly expense for most families, meaning it weighs heavily on inflation calculations. Unless housing prices fall, it will be difficult for inflation as a whole to sustainably return to the central bank’s 2% target.

“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 housing research firm. Housing inflation, he added, “is not slowing at the rate that 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, showing that rents have barely increased recently and fallen altogether in some markets.

For home buyers, the combination of rising prices and high interest rates has made housing increasingly unaffordable. In contrast, many existing homeowners have been partially protected from rising prices because they have fixed-rate mortgages whose payments do not change from month to month.

However, house prices and mortgage rates do not appear directly in inflation data. That’s because buying a home is an investment, not just a consumer purchase like groceries. Instead, inflation data is based on rents. And as private data shows a moderation in rents, economists expect the slowdown to show up in government data as well.

Federal Reserve officials largely dismissed housing inflation for much of last year, believing that official data had simply been slow to reflect the slowing trend apparent in private data. Instead, they focused on measures that exclude housing, an approach they say better reflects underlying trends.

But as the divergence persists, some economists, inside and outside the Fed, have begun to question those assumptions. Economists at Goldman Sachs recently raised their forecasts for housing inflation this year, citing rising rents for single-family homes.

“There’s 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 looking at?’ I would say, “I’m watching the accommodation because that’s what’s still weird.”

The stubborn nature of housing inflation is not a complete mystery. Economists knew it would take time for the rent moderation seen in private-sector data to show up in 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 homes. However, a given unit is only inspected once every six months. So, if an apartment is inspected in January and the rent increases in February, that increase will not show up in the data until the apartment is inspected again in July. This causes government data to lag conditions, particularly during periods of rapid change.

The second reason is conceptual. Most private indexes only include rentals when recruiting new tenants. But the government aims to capture housing costs for all tenants. Since most leases last a year or more and those who renew their leases often receive a discount compared to those renting on the open market, government data will generally adjust more gradually than private indexes.

Public and private data should eventually converge. But it is unclear how long this process will take. Rapidly rising rents in 2021 and 2022, for example, have led many people to stay put rather than jump into the hot rental market. This, among other factors, may have meant that it took longer than usual for market rents to be filtered into government data.

There are signs that a slowdown is underway. Rents have risen at an annual rate of less than 5% over the past three months, compared with a peak of nearly 10% in 2022. Private data sources disagree on the degree of slowdown. rent inflation, but they agree that the trend is likely to continue.

“Essentially, 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.

Although rent inflation may finally be moderating, government measurement of costs for landlords has not followed suit; it actually accelerated in the last month’s data. And because more Americans own their homes than rent, owner-occupied homes dominate the housing component of the consumer price index.

Expenses that most people associate with homeownership – mortgage payments, home insurance, maintenance and repairs – are not directly included in inflation measures.

Instead, the government measures housing inflation for homeowners by assessing how much it would cost to rent a similar home, a concept known as owner-equivalent rent. (The idea is that this measures the value of the “service” of providing housing, as opposed to the investment gains of owning it.)

Rental and homeownership measures typically move together because they are based on the same underlying data: the survey of thousands of rental homes. But when calculating homeownership figures, the Labor Department gives more weight to homes that are comparable to owner-occupied homes. This means that if different housing types behave differently, the two measures may diverge.

This may be what is happening now, some economists believe. The boom in apartment construction in recent years has helped drive down rents in many cities. Single-family homes, however, remain rare, just as millions of millennials reach the stage where they want more space. This drives up the cost of homes for both buyers and renters. And because most homeowners live in single-family homes, single-family units play an outsized role in calculating homeowners’ equivalent rent.

“There is more heat behind single-family homes, and there are very good arguments for why that heat is going to persist,” said Skylar Olsen, chief economist at Zillow.

Other economists doubt that January’s rise in inflation is the start of a more lasting trend. Rents for single-family homes have outpaced those for apartments for some time now, but only recently has inflation between homeowners and renters diverged. That suggests the January data was a fluke, argued Omair Sharif, founder of Inflation Insights, an economic research firm.

“Things from month to month in general can be volatile,” Mr. Sharif said. The good news from the report, he said, is that rent growth has finally started to slow, making him more confident that the long-awaited slowdown is emerging in official data.

This conclusion, however, is far from certain. Before the pandemic, the different segments of the real estate market showed generally consistent developments: apartment rents increased at roughly the same rate as those of single-family homes, for example.

But the pandemic has destroyed this balance, causing rents to rise in some places and fall in others, disrupting the relationships between the different measures. So it’s hard to know for sure when, or to what extent, official data will moderate — which could make the Fed more cautious as it considers cutting interest rates, said Sarah House, senior economist at Wells Fargo.

“Right now, they continue to assume that there’s still a lot of disinflation going on, but that’s going to keep them cautious in their optimism,” she said, referring to Fed officials. “They need to think about where the shelter actually is and how long it takes to get there.”

Audio produced by Tally Abécassis.