The costs of construction — from materials to labor — lead many developers to favor luxury home building over starter homes because they offer a higher return per square foot. (Spencer Platt | Getty Images)
Housing costs, including rental prices, are on the path to stabilizing but evidence of this won’t show up in inflation measures anytime soon, economists say.
The latest Consumer Price Index numbers, which are used to measure inflation, came out on Thursday morning. The CPI increased 0.4% in October, the same as in September. The CPI rose 7.7% for the 12 months ended October 2022. That was down from 8.2% for the 12 months ended September 2022.
The index for shelter rose 6.9% for the 12 months ended October 2022. The Bureau of Labor Statistics said the shelter index accounted for more than half of the increase in the month of October. The survey used to measure shelter, a large component of inflation, lags real-time data, however.
After the Federal Reserve raised interest rates again this month, Fed chair Jerome Powell was asked how the Fed considers private real-time housing market data when making decisions about interest rates. Powell said that although the Fed is aware of the data, it still looks at the Consumer Price Index (CPI) and Personal Consumption Expenditures (PCE) to understand how it should respond to inflation because it’s important for the Fed to understand rent for all tenants, not just new leases. But he added that rent should start to come down eventually.
“One thing is that I think right now, if you look at the pattern of that series of the new leases, it’s very pro-cyclical. So rents went up much more than the CPI and PCE rents did and now they’re coming down faster,” he said. “ … The new leases are telling you there will come a point at which rent inflation will start to come down but that point is well out from where we are now … at some point, you’ll see rents coming down.”
Economists spoke to States Newsroom about what factors are affecting the health of the housing market right now.
A turning point
Month-over-month data from Rent.com for September, the latest month available, shows rent prices are finally starting to moderate. Year-over-year rent increases were up 8.8% in September compared to a 12.3% increase in August. In the states Rent.com looked at median month-over-month rent fell in more than 60% of markets.
John O’Trakoun, senior policy economist in the research department of the Federal Reserve Bank of Richmond, said it’s possible that the moderation in rent prices is a good sign for the economy but added that it could take more than a year for the private data to show up in lagging economic indicators.
“I think it is kind of encouraging. Hopefully, in like 18 months or so, we’ll start to see this inflection point in the asking rent to flow through into the CPI and PCE [Personal Consumption Expenditures] shelter components. But in the meantime, we’ve got to keep the pressure going on inflation and slow down demand in order to better match with supply constraints,” he said.
Thomas LaSalvia, senior economist at Moody’s Analytics, said that although he sees rent growth falling, he doesn’t expect to see a big change in rental prices unless there is a lot more stress in the labor market. The latest jobs report showed that in October, the unemployment rate rose by 0.2% and that the percentage of people working or actively looking for work hadn’t changed significantly from 62.3% in October to 62.2% in September.
LaSalvia and Lu Chen, senior economist at Moody’s Analytics, said that in terms of housing affordability, on an average basis, they don’t see the rent burden “continually growing.”
Inflation creating the wrong incentives for builders
O’Trakoun said inflation is still exacerbating problems with the housing supply, including a lack of starter homes. He said that if inflation goes down, it could stop affecting construction costs, which in turn hurts the housing supply.
“Part of that is because the cost of construction has gone up and finding construction workers and compensating them has gone up. I think it’s partly the choice of builders who are like, ‘Well look, it’s so expensive to build this, I’m going to build those properties that offer a higher return per square foot,’ and that’s why we’ve seen this kind of reallocation.”
O’Trakoun added that construction costs should level off once the Fed gets inflation under control.
The seasonally adjusted rate of privately-owned housing starts in September was 1,439,000, compared to 1,566,000 housing starts in August.
According to the National Association of Realtors, first-time home buyers made up 26% of the market in the year that ended July 22, a drop from 34% during the same period the previous year.
‘Pandemic darling’ markets are cooling down
Earlier in the pandemic, people from higher-income areas moved to cities with lower housing prices and caused those prices to soar, but Moody’s Analytics economists say those areas are finally beginning to cool down. They said to watch out for rental prices moderating in places like Miami, Orlando, Raleigh, Salt Lake City, Tampa, and Jacksonville, and in general, metropolitan areas in the Southeast and Southwest and the Mountain West.
“A lot of these markets went from rent growth in the market of 4% or 5% quarter over quarter — sometimes more than that — down to below average, and I think we’re getting to a point where that’s the emerging interesting story, is the deceleration in those pandemic period darlings. … They’ve lost the momentum of that in-migration of those higher income households,” LaSalvia said.
Chen said these “pandemic darling” markets are experiencing a correction in rental market prices now that fewer people are moving to these areas.
Mortgage rates helping home buyers?
The past few years of low interest rates, low inventory and investor speculation have been a boon to home sellers but priced many home buyers out of the market and helped push rental prices higher.
But with mortgage rates near their highest levels in 20 years, markets are starting to adjust.
“Investor housing purchases appear to have plateaued just under the record high levels we saw in the third quarter of 2021,” O’Trakoun said.
He doesn’t expect investors to completely leave the market, however, noting that some may take advantage of less competition, and that will keep home prices from falling as rapidly as they otherwise might. The change could also affect the rental market, he said, as some investors will convert the homes they buy into rentals to take advantage of strong demand.
He added that because of high mortgage rates, some markets could see increases. That’s why it’s so important for the Fed right now not to bank on just one reading of the month-over-month listing of rents coming down and declaring victory on inflation too soon,” he said.
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