Housing inflation is still stubbornly high, even as broader U.S. inflation has significantly cooled from its pandemic peaks.
Its painfully slow decline is a key factor preventing the consumer price index (CPI) from reaching policymakers’ targets, economists say.
“We see it as the last remaining leg” explains Joe Seydl, senior markets economist at J.P. Morgan Private Bank.
Housing, which accounts for 36% of the CPI index, has a significant influence on inflation readings due to its status as the largest expense for the average household.
At a high level, “shelter” inflation reflects U.S. rental prices, says Jessica Lautz, deputy chief economist at the National Association of Realtors.
However, the Bureau of Labor Statistics (BLS) methodology means the shelter inflation index lags behind real-time rental market trends.
Why Shelter Inflation is Slow to Decline
Shelter inflation has been slow to retreat, falling to a 5.2% annual rate in June 2024 from a peak of around 8% in early 2023. This level is still about 2 percentage points above its pre-pandemic baseline.
“[Shelter] has moved in the right direction,” says Olivia Cross, a North America economist at Capital Economics. “It’s just moving much, much slower than anyone really expected.”
This slow pace contrasts sharply with the current rental market, where new rental contract inflation has dropped to 0.4% in the first quarter of the year, from highs of around 12% two years ago, per BLS data.
The discrepancy is due to the BLS’s construction of its housing inflation index, which leads to delayed changes in shelter CPI readings.
“We’ve found now that there are big lags,” Federal Reserve Chair Jerome Powell said in June. It could take “several years” for shelter CPI to reflect recent rental market trends, he added.
The Fed is aware of this lag and considers it when making inflation-related decisions, notes Selma Hepp, chief economist at CoreLogic.
How CPI Reflects Homeownership
The shelter inflation index measures the average cost of housing in the U.S., incorporating both rent and “owners’ equivalent rent of residences.”
For renters, assessing changes in spending is straightforward. However, most Americans are homeowners, and their regular costs—mortgages, property taxes, and maintenance—are treated as capital costs rather than consumption.
Thus, they don’t fit neatly into the CPI basket.
“When it comes to the CPI, [shelter] does not mean the cost for homes for purchase,”says Lautz.
The BLS uses “owners’ equivalent rent” (OER) to equate homeowners with renters, measuring the potential rental value of owned homes.
This framework has been in place since 1987 and is common in many countries for gauging inflation, Powell says.
Constructing the Shelter Index
Since rents don’t change monthly, the BLS constructs its CPI shelter index by sampling a staggered panel of renters and homeowners, explains Seydl.
This sample is split into six groups, each surveyed every six months, aggregating price changes into the overall shelter index.
Due to this staggered nature, the index moves slowly and lags behind current market trends.
“What we’re seeing in the CPI data has already happened in the nine to 12 months prior,” said CoreLogic’s Hepp.
Shelter inflation is expected to moderate as it catches up to current rental trends and as more rental units become available.
“We’ll continue to see slowing or deceleration in the rent component,” Hepp adds.
Pandemic-driven rental price increases were due to demand outpacing supply, causing a surge in rental prices.
As more multifamily units are built, the increased supply is meeting demand, helping to slow rent growth, Lautz explains.
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