Tuesday, April 22, 2008

Rents and the CPI

Remember that part where the CPI is not tied to housing prices but instead to rental prices and owner equivalent rent? It was claimed by some (the CPI being seriously cooked conspiracy theorists?) that it was therefore dramatically understating consumer inflation. I argued that it was just a short-term situation. Rents would either rise to match housing prices eventually, housing prices would fall, OR they would meet in the middle. This was the entire reason the government uses rents instead of home prices. It doesn't want the CPI tied to bubbles. I am and have been fine with that line of thinking.

Times are a changin'. Housing prices are falling. Rental prices are rising.

Renters can't escape housing foreclosure crisis

The most brutal real estate slump in decades is reverberating through the rental market. Renters in properties that are being foreclosed on are being evicted. Homeowners forced into foreclosure are becoming tenants again and driving up rents. And renters not yet ready to buy a home — shut out by stricter lending rules or hoping to buy after prices fall still further — are creating a dynamic shift: Even as real estate is sputtering, the rental market is surging.

Keep in mind this puts additional stress on the CPI (in addition to the obvious stress of $119.90 oil and rising import prices in general due to a falling dollar). Also keep in mind that TIPS (treasury inflation protected securities) are tied to the CPI.

Consumer Price Indexes for Rent and Rental Equivalence

Until the early 1980s, the CPI used what is called the asset price method to measure the change in the costs of owner-occupied housing. The asset price method treats the purchase of an asset, such as a house, as it does the purchase of any consumer good. Because the asset price method can lead to inappropriate results for goods that are purchased largely for investment reasons, the CPI implemented the rental equivalence approach to measuring price change for owner-occupied housing. It was implemented for the CPI-U in January 1983 and for the CPI for Urban Wage Earners and Clerical Workers (CPI-W) in January 1985.

In other words, "investment reasons" often lead to bubbles.


Anonymous said...

Rents are increasing? You are telling me that with a massive oversupply of houses rents are going to increase? I'm going to see more rigorous data before I believe it.

Stagflationary Mark said...


Keep in mind that an empty house does not count. Most renters do not rent houses. They rent apartments. That's my take on it anyway.

This same thing happened during the consumer recession in the early 1990s.

How Home Prices Can Be Hot but Inflation Cool


CONVERSELY, when housing prices fall, a trend that most people would deem anti-inflationary, and renting becomes more attractive than owning, the index might process the information as evidence that inflation is on the rise. "We got a great deal of criticism that we were overstating inflation in the early 1990's, because housing prices were declining and rents were going up steadily," Mr. Jackman said.

dearieme said...

It surely must just be temporary - once the foreclosed houses have got through the court system and onto the market, investors will presumably buy them to let out, and rents will fall again.

Stagflationary Mark said...


Yeah, I think it is safe to say that the effect is at least somewhat temporary.

Of course, if investors feel that there will be rental price deflation they might not be so willing to buy them to let them out. I think that's what we are seeing in some places anyway. Meanwhile, the entity trying to sell the property won't be renting it out either (since it is harder to sell with a renter in it).

That's not to say that there aren't pockets of serious rental price deflation though (as seen in the following link). At some point the sheer volume of empty units overwhelms the rental market obviously (say in Phoenix for example).

Apartment rental costs are all over the map


In any event, owners' equivalent rent continues to rise fairly steadily as seen in the detailed CPI reports.


Dec to Jan: +0.3%
Jan to Feb: +0.2%
Feb to Mar: +0.2%

Not much deflation there yet, even as housing prices continue to fall. I'm certainly not trying to suggest rental prices are going to shoot up from here. I'm simply suggesting that rental prices and home prices seem to be converging (the former continues to rise as the latter continues to fall) as they have in previous housing busts.

If rental prices actually start to fall (which is also possible in theory, especially based on the magnitude of this bubble), then watch out below on housing prices. We'll also see Bernanke firing up the helicopters, again. Sigh.

Stagflationary Mark said...


I used the rent of primary residence line from the report instead of the owners' equivalent rent line.

Dec to Jan: +0.3%
Jan to Feb: +0.1%
Feb to Mar: +0.2%

MAB said...


I've been thinking about my personal inflation a whole lot lately. And it has definitely been above 4% yoy. Your comments made me realize that almost all home owners have been experiencing inflation above the headline 4.1%.

If rents or equivalent rents are approximtely 32% of CPI and are at 2.4% +/- yoy, then the remaining 68% of the CPI is running really hot. It's like someone poured gasoline on it and lit a match.

It's a double whammy for families that are being hit with mortgage rate increases.

I can't wait for these rate cuts to kick start the economy. The whole world needs a raise.

Stagflationary Mark said...


I can't wait for these rate cuts to kick start the economy. The whole world needs a raise.

Looks like you might have to wait.

Rates on 30-year mortgages top 6 percent

WASHINGTON (AP) — Rates on 30-year mortgages topped 6 percent for the first time in six weeks as financial markets grew more worried about rising inflation pressures.

Money is flowing out of treasuries and back into the stock market it seems. The unintended side effect is that interest rates are rising, mortgage rates are rising, and real yields are rising (as seen in TIPS). The unintended consequences are that it will add even more pressure to the struggling housing market.

Initial unemployment claims were down more than expected today though. On the other hand, it will be interesting to see if that carries over to actual job creation/hiring. Why am I suspect?