The housing sector may be the hero we need against inflation.
Surprising Relief
In a year marked by soaring home prices and inflationary pressures, a surprising relief might be on the horizon: the housing sector is poised to play a pivotal role in curbing inflation in 2024.
As the battle against inflation reaches its “last mile,” namely shelter, which constitutes a significant portion of the Consumer Price Index (CPI), emerges as a critical factor in the inflation equation.
Consumer prices saw a 3.1% increase in November compared to the previous year, with shelter costs contributing significantly to this surge, rising by 6.5% year-on-year.
Predicting a Shift
However, economists predict a shift in the dynamics of shelter-related inflation, with expectations that it will begin to decelerate. Despite this year’s record-breaking 3.4% increase in home prices, the focus is turning to rents rather than home prices.
Shelter inflation is intricately tied to rents, and recent trends indicate a slowdown. Rent growth through November stood at 3.3%, a decline from the average during 2018-2019.
The impact of slowing rents takes time to manifest in the CPI. Rent adjustments for most tenants typically occur once a year, causing a lag in reflecting current market conditions.
The Bureau of Labor Statistics employs a six-month moving average, further contributing to the data lag.
What is Shelter Inflation?
Shelter inflation encompasses both tenant rents (7.7% of the CPI) and owner-occupied housing (25.8% of the CPI). Tenant rent calculations include new and existing leases, compounding the lag in reflecting market changes.
For owner-occupied housing, the Bureau of Labor Statistics uses owner-equivalent rent, factoring in the hypothetical rent a homeowner would pay to rent their property.
Despite the seemingly paradoxical nature of slowing shelter inflation amid rising home prices, this trend is tied to rental markets rather than property values. As rents cool down, they are expected to exert downward pressure on inflation in 2024.
Predicting the Decline
Alan Detmeister, an economist at UBS, predicts a decline in the shelter component of CPI inflation to 3.75% by the end of 2024.
This projection aligns with the broader economic sentiment that slowing rents will be a key driver in moderating inflation next year.
Acknowledging this trend, the Federal Reserve has signaled potential interest rate cuts in response to the flattening of housing sector activity. Fed Chair Jerome Powell noted at a recent press conference that housing activity remains below previous levels.
Seattle-Tacoma Statistics
An analysis of specific metro areas, such as Seattle-Tacoma, underscores the complexity of the inflation picture. Despite experiencing one of the highest inflation rates, driven primarily by shelter inflation, Seattle has witnessed a decline in rents since April.
Experts anticipate a further decline in home values and rents in the coming months, influenced by rising vacancies.
While the national multifamily supply boom has contributed to cooler rent growth, challenges persist due to a housing shortage. Demographic pressures from Gen Z and millennials, coupled with limited single-family housing supply, continue to exert upward pressure on prices.
Evolving Dynamics
Changes in the housing market, like shifting rent prices and home values, are playing a big role in how inflation might shape up this year.
As the year unfolds, the complex link between housing, inflation, and broader economic indicators will likely continue, creating a narrative where the housing sector emerges as both a challenge and a potential solution in the ongoing battle against inflation.
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The content of this article is for informational purposes only and does not constitute or replace professional financial advice.
