Discussions around shelter inflation have taken center stage given it accounts for roughly 30% of the CPI (Consumer Price Index) basket. Shelter CPI, which includes both owners' equivalent rent and rent, accelerated to 6.9% y/y in October 2022, its highest reading since 1982. The outlook for shelter is critical to understanding the path for CPI inflation.
There is no shortage of alternative data on rents. Here we look at data from four sources: Zillow, ApartmentList, Yardi Matrix and Thinknum. Each data source has slightly different methodologies but generally provide measures of asking rents.
Comparing these measures to the CPI rent index, there are a few observations that immediately jump out. First, CPI rent is smoother than these measures. Second, alternative rent inflation slowed more than CPI rents during the early stages of the pandemic, peaked earlier than CPI rents and likely peaked at a higher level. These two observations can be explained by the difference in scope between the types of rent data. Alternative data captures “asking” or “marginal” rents, while CPI data captures “average” rents. Third, all alternative measures show a moderation in rent price inflation since peaking earlier in the year and rents in some of the cities that benefitted from in-migration in the earlier stages of the pandemic are seeing asking rents fall vs. last year.
Our shelter forecast
We expect CPI rent to moderate, alt-data suggests asking rents are now falling and these rents tend to lead the CPI rent index. The million-dollar questions are when and by how much? In our opinion, CPI rent and in turn shelter inflation, on a year-over-year basis, should peak next February and then steadily move lower over the course of our forecast horizon as they begin to reflect the moderation in asking rents. Admittedly, there is a risk that the turn happens earlier or later than we expect as it is difficult to time the turning point.
However, we do not expect a swift return to pre-pandemic price trends. The main reason for this, is because rising mortgage rates should, all else equal, lead to stronger demand for rents. The ongoing affordability shock for homeownership will limit transitions from rents to home ownership. This should keep rental vacancies depressed. As a result we expect shelter inflation to remain above pre-pandemic levels throughout our forecast horizon. That said, sky-high rental prices and increased economic uncertainty could also depress rental demand, lead to increased bunking up, living with family, and a lack of churn in rental properties. Therefore, we do think there are risks of a faster deceleration than we currently expect.