Housing inflation has remained stubbornly high, even as inflation in the broader US economy has eased significantly from peak levels during the pandemic.
Its painfully slow decline is the main obstacle to its preservation consumer price index from returning to policymakers’ target, economists said.
“We see this as the last remaining leg” before the CPI normalizes, explained Joe Seydl, senior market economist at JP Morgan Private Bank.
Housing accounts for 36% of the CPI index – by far the largest share compared to other categories such as food and energy – as it is the biggest expense for the average household. As such, movements in housing prices have a large influence on inflation measurements.
At a high level, “shelter” inflation is a measure of U.S. rental prices, said Jessica Lautz, deputy chief economist at the National Association of Realtors.
But the way the Bureau of Labor Statistics calculates these values means that the shelter inflation index lags real-time trends in the rental market (as explained in more detail below).
Because CPI shelter inflation has slowly declined
The retreat in shelter inflation was slower than expected, economists said.
It fell to an annual rate of 5.2% in June 2024 from a peak of around 8% in early 2023, according to the CPI data. Its current level is about 2 percentage points above the pre-pandemic baseline.
“[Shelter] it has moved in the right direction,” said Olivia Cross, North America economist at Capital Economics. “It’s just moving much, much slower than expected.”
This dynamic may seem at odds with the current state of the rental market.
The annual inflation rate for new rentals has eased to 0.4 percent in the first quarter of the year — lower than its pre-pandemic baseline — from record highs of about 12 percent just two years earlier, according to the BLS data.
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The reason for the glacial pace of the shelter in the CPI data is largely a function of how the federal government constructs its housing inflation index, economists said.
The government’s methodology means that changes in shelter CPI readings lag behind those in the current rental market.
“We have now found that there are long delays,” Federal Reserve Chairman Jerome Powell said he said in June. It may take “several years” for shelter CPI readings to reflect recent dynamics in the rental market, he added.
“When the Federal Reserve is looking [at] what’s going on with inflation, they’re very aware of that concern of that shelter delay and they’re taking that into account when they’re making decisions about what to do about inflation,” said Selma Hepp, chief economist at CoreLogic.
How the CPI Reflects Home Ownership
The housing inflation index is meant to measure the average cost of housing in the U.S. economy, said JP Morgan’s Seydl. Its two main components are rent and “equivalent owner-occupancy rent”.
Assessing changes in spending for tenants, who pay a monthly rent to their landlords, is straightforward.
But most Americans are homeowners. For them, calculus is harder: The BLS considers owner-occupied housing units as investments, not consumption goods.
[Shelter] has moved in the right direction. It just moves much, much slower than anyone really expected.
Olivia Cross
North American Economist at Capital Econoics
Regular expenses that homeowners incur — such as mortgage, property taxes, property fees, most maintenance and all improvement costs — are treated as “capital” expenses, not consumption. They don’t fit neatly into the CPI basket, which measures changes in the prices of goods and services Americans consume.
“When it comes to the CPI, [shelter] it doesn’t mean the cost for homes to buy,” said NAR’s Lautz.
The BLS uses the “Owner Equivalent Rent” (OER) category to put homeowners on a level playing field with renters. The meters the “value a homeowner could have received by renting the good (ie, the house) instead of using it himself,” according to the BLS.
BLS has been using this framework since 1987, the agency he said.
Imputing rental value to owner-occupied homes is something “many countries around the world do” when calculating inflation, Powell said in June.
How the BLS constructs the shelter index
Because rents generally don’t change from month to month, the government constructs the CPI shelter index by sampling a “stratified group” of renters and homeowners, Seidle said.
It divides the sample into six groups and surveys each on a staggered basis every six months. For example, House A is voted in January and July, House B in February and August, and so on. Aggregates price changes in the overall shelter index.
The index moves slowly and lags because of the staggered nature of the data, economists said.
“What we’re seeing in the CPI data has already happened nine to 12 months ago,” said CoreLogic’s Hepp.
Housing inflation should continue to moderate as it responds to the trend of new rental contracts and, in general, as more rental units become available, experts say.
“We will continue to see a slowdown or slowdown in the rental component,” Hepp said.
Rental prices rose during the pandemic because demand outstripped supply, which caused rental prices to rise, he said.
“One of the reasons rent growth has slowed is because there’s more construction of multifamily units,” Lautz said. “It makes more of the demand that was really limited.”
