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

The Fed may have a housing problem. At the very least, it has a housing mystery.

The overall inflation rate has declined significantly over the past year. But housing has proven to be a stubborn – and surprising – exception. Shelter costs rose 6% in January from a year earlier, and rose faster on a month-over-month basis than in December, according to the Labor Department. This acceleration was a large reason for the rise in overall consumer prices last month.

Continued housing inflation poses a problem for Fed officials as they consider when to cut interest rates. Housing is the largest monthly expense for most households, which means it greatly impacts inflation calculations. Unless housing costs cool off, it will be difficult for inflation as a whole to return sustainably 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 Franceschi, managing director at Zelman & Co., a housing research firm. He added that housing inflation “is not slowing at the rate that we or anyone expected.”

These projections were based on private sector data from real estate sites such as Zillow, Apartment List and other private companies that showed that rents had barely risen recently, and were falling directly in some markets.

For homebuyers, the combination of rising prices and rising interest rates has made housing increasingly unaffordable. On the other hand, many existing homeowners were partially insulated from rising prices because they obtained fixed-rate mortgages with payments that did not change from month to month.

However, housing prices and mortgage rates do not appear directly in inflation data. This is because buying a home is an investment, not just a consumer purchase like groceries. Instead, inflation data is based on rents. With private data showing rents moderating, economists were looking for a slowdown to appear in government data as well.

Federal Reserve officials largely dismissed housing inflation for much of last year, believing that official data was simply slow to capture the slowing trend evident in private data. Instead, they focused on measures that excluded shelter, an approach they saw as better reflecting underlying trends.

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

“Clearly there is 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 watching?” I would say, “I'm keeping an eye on housing because that's the thing that's still weird.”

Delayed data

The stubborn nature of housing inflation is not a complete mystery. Economists knew it would take some time for the moderation in rents shown by private sector data to trickle down to 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 particular unit is only scanned once every six months. So, if an apartment is surveyed in January and the rent goes up 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, especially during periods of rapid change.

The second reason is conceptual. Most private indexes only include rentals when they get new tenants. But the government aims to cover housing costs for all tenants. Because most leases last for a year or more, and because those who renew their leases often get a discount relative to people who rent on the open market, government data will usually be revised more gradually than private indicators.

Public and private data should eventually converge. But it is not clear how long this process will take. For example, the rapid rise in rents in 2021 and 2022 caused many people to stay put rather than delve into the hot rental market. This, among other factors, may have made it take longer than usual for market rents to be filtered out 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, down from a peak near 10 percent in 2022. Private data sources differ on how much of a decline rent inflation still has to go, but they agree that the trend should Continue.

“For the most part, they are all saying the same thing, which is that rent inflation has moderated significantly,” said Laura Rosner Warburton, chief economist at economic research firm Macropolicy Perspectives.

Houses versus apartments

Although rent inflation may finally be moderating, the government's measurement of costs to landlords has not followed suit; It has already accelerated in the latest month's data. Because more Americans own their homes than rent, owner-occupied housing dominates the shelter component of the CPI.

The expenses that most people associate with homeownership — mortgage payments, homeowners insurance, maintenance and repairs — are not directly included in inflation measures.

Instead, the government measures housing inflation for owners by assessing the cost of renting a similar home, a concept known as owner-occupied rental equivalents. (The idea is that this measures the value of the “service” of providing housing, as distinct from the investment gains of owning it.)

Rent and ownership metrics typically move together because they're based on the same basic data — a survey of thousands of rental units. But to calculate ownership figures, the Labor Department gives more weight to homes that are comparable to owner-occupied units. This means that if different types of housing behave differently, the two measures can vary.

Some economists say this may be what is happening now. The boom in apartment construction in recent years has helped drive down rents in many cities. However, single-family homes are still in short supply, as millions of millennials reach the point where they want more space. This results in higher cost of homes for both buyers and renters. Because most homeowners live in single-family homes, single-family units play a large role in calculating owner-equivalent rent.

“There's more heat behind single-family households, and there are very good arguments to be made about why that heat will persist,” said Skyler Olsen, chief economist at Zillow.

Luck or something more?

Other economists doubt that January's rise in inflation is the beginning of a more sustainable trend. Single-family home rents have outpaced apartment rents for a while, but only recently has inflation diverged between owners and renters. This suggests the January data was a fluke, said Omair Sharif, founder of Inflation Insights, an economic research firm.

Sherif said: “Monthly matters in general can be volatile.” He said the good news in the report is that rental growth is finally starting to cool off, making him more confident that the long-awaited slowdown will show up in the official data.

But this conclusion is not at all certain. Before the pandemic, different parts of the housing market told generally consistent stories: Apartment rents rose at the same rate as rents for single-family homes, for example.

But the pandemic has destroyed this balance, causing rents to rise in some places and fall in others, and disrupting relationships between different scales. This makes it difficult to be confident about when official data will calm, or to what extent, said Sarah House, chief economist at Wells Fargo Bank – which could make the Fed more cautious when it considers cutting interest rates.

“Right now, they are still assuming that there is still a lot of inflation slowing ahead, but that will keep them cautious in their optimism,” she said, referring to Fed officials. “They have to think about where the shelter is actually going to go, and how long it will take to get there.”

Audio produced by Tali Abekasis.