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Rent Inflation Is About to Surge Forth and It Won’t Stop, Two Fed Economists Say – Silver Doctors

Two Federal Reserve economists are warning of an acceleration in rent inflation over the years to come, casting doubt over policy makers’ bet that overall pricing pressure is indeed temporary.

In a recent report, Xiaoqing Zhou and Jim Dolmas of the Federal Reserve Bank of Dallas say that since the Covid-19 pandemic began in February 2020, the inflation rates of rent and owners’ equivalent rent—which is how economists convert housing from an asset to a service for the purpose of measuring inflation—have declined sharply to around 2%. That’s compared with 3.7% and 3.3%, respectively, before the pandemic. 

But a booming housing market with home prices continuing to reach new highs means rents, too, are set to explode. For investors, that presents opportunities in real estate stocks such as AvalonBay Communities (ticker: AVB), Essex Property Trust (ESS), and Equity Residential (EQR). It is also a risk to the macroeconomic outlook shared by many Fed officials and economists across Wall Street.

House-price growth, expressed as a 12-month growth rate, has historically led rent inflation and OER inflation by somewhat less than two years, Zhou and Dolmas say. The high correlations between current house price growth and future inflation of rent and OER suggest that house price growth is useful for forecasting the inflation rates of those housing components, they say, which together make about 40% of the total consumer price index.

The translation: Investors should expect to see the surge in house prices that started roughly 18 months ago begin to push up rents, and in turn drive overall inflation gauges higher. Some economists have said the federal eviction moratorium put in place at the start of the pandemic prevented rents from rising as much as they otherwise might have. The Supreme Court struck down the Biden administration’s efforts to extend the moratorium, lifting that effective cap on rent prices, though 13 states including New York and California have their own extensions in place. 

Looking ahead, Zhou and Dolmas say they expect rent inflation to rise at a 3% pace and OER inflation to increase at a 3.8% pace by the end of next year. More importantly, they see both rent and OER inflation rising at 6.9% clips by the end of 2023. That would be the fastest in 30 years, and it is well after officials have suggested pricing pressures would cool—an expectation that is core to current interest-rate projections. 

The Fed’s favorite measure of inflation is the personal consumption expenditure index, with food and energy excluded. Housing also makes up the biggest portion of the PCE, though at about 23% the weighting is much smaller than in the CPI. 

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