The new year brings a flood of predictions about the year to come. Some milestones of the more distant future (e.g., the Year 2000) prod more long-term forecasts for the economy, technology, exploration, and lifestyle. Those predictions are illustrative of the obsession we humans have for knowing the future before its comes upon us.
Not all forecasting is whimsical. In some ways, our lives can depend fundamentally on predicting the future. Knowing the near-future cost of housing is particularly important. We all require shelter, and housing costs comprise 30% or more of spending for the typical U.S. household. When housing costs rise dramatically, as they have over the past few years, lifestyles and basic affordability suffer.
Historical Efforts to Forecast Housing Costs
During World War II, western countries began measuring consumer inflation aware that the war effort was causing a spike in the cost of living. By the 1950s, the U.S. federal government began including the cost of housing (purchase and rent) in measures of inflation, recognizing the large impact of housing costs on consumer spending. As statistical methods became more sophisticated and focused on consumption, not investment, the Bureau of Labor Statistics (“BLS”) at the federal Department of Labor narrowed its measure of housing cost to rent or rent equivalent for owner-occupied housing.
Measuring the cost of housing is notoriously difficult, especially before former Vice President Al Gore invented the internet. Most consumer transactions occur frequently in public retail stores or now on widely accessible websites. The transactions are reported to state taxing authorities in the aggregate (e.g., a grocery store purchase) and sometimes per item purchase (e.g., a car). Prices for most consumer goods are advertised or readily discovered.
Renting a home occurs much differently. Most people rent a home once a year. The lease is signed in private and not reported to any government agency. Many landlords own one or a few units and do not advertise asking rent. Concessions by the landlord may be hidden in a lease addendum or not written at all, making any advertised rent inaccurate.
For these reasons, among others, measuring rents is difficult and very much like the experience of observing lightning — the flash of light appears before the sound arrives and the spread depends on the distance away of the lightning strike. The rent paid for a particular property depends, in part at least, on how long the tenant has occupied the property. The farther in the past that the tenant signed the lease, the less accurate is the rent in that lease as an indicator of current rental value.
The BLS long has battled the challenge of measuring rent (and calculating the Owners’ Equivalent Rent). The agency’s methodology is well-regarded but inherently fraught with inaccuracies. The data on rent is collected by personal visits and phone calls to thousands of properties. Because rental units historically do not turnover frequently, the survey measures the rent of each unit once every six months. So, the housing cost component of the Consumer Price Index gauge of inflation may reflect data that is months old.
The BLS also does not consider variables that can materially affect the rental rate in a new lease. Existing tenants, for example, may be treated differently from new tenants. An existing tenant is a known person with whom the landlord has personal history. The history can persuade a landlord to limit a rent increase or push the market limits. The rental rate for a potential new tenant is influenced almost entirely by current market dynamics and objective measures of the potential new tenant.
Various Indices of Rent Inflation Differ Widely
When rent is rising rapidly as it did in 2021 and 2022, the CPI inevitably underreports the true current housing cost inflation rate. The BLS methodology cannot quickly capture significant changes in rents that occur in days or weeks. The result is a CPI that lags current market conditions, exactly as occurred in the first quarter of 2022.
The rise of the Internet brought to the scene many private attempts to supplement the BLS measurement techniques. Zillow created its Observed Rent Index. ApartmentList delivers a National Rent Report each month. CoreLogic publishes an index focused on single-family rentals.
These firms have current data but not necessarily data on the amount of rent to which a tenant and landlord agreed. The data is primarily from listings, which contain an asking price. The agreed rent may be higher or lower, depending on many factors and especially the momentum of the market. The listings also likely are not a representative sample of all for-rent housing in any market. Zillow and CoreLogic, as examples, disproportionately collect data for higher-end single-family homes.
The variability among various rent measures poses challenges for all the players in rental housing. The lag necessarily slows the response of policymakers, landlords, tenants, investors, and . . . well, everyone . . . to the impact of rising rents. The response-time delay has been especially palpable in the last year as the Federal Reserve has been ratcheting higher interest rates to slow inflation.
New Tenants Caffeinate the Measurement of Rents
Considering the lag in BLS data and variability of private data, economists from the BLS and the Federal Reserve Bank of Cleveland formulated a new methodology for measuring current rents. The new metric — the New Tenant Repeat Rent Index — uses detailed BLS data to capture the rent to which a tenant has agreed to pay to occupy a property for the first time (in contrast to a renewing tenant). The NTRRI is especially relevant to investors and landlords considering a new project because the NTRRI most accurately reflects the rent that a new project could expect as units become available for the first time.
Among the authors’ conclusions that shed light on the CPI and private firm measures of rent:
- Most of the variability among the various measures of rent is attributable to the effect of new tenant leases on the overall measure of rents.
- The rent paid by new tenants reflects current rent inflation a year before the BLS measure of housing cost in the CPI.
- The housing component of the CPI most accurately measures the experiences of renewing tenants.
- The data used by Zillow and CoreLogic are not representative of the general rental market because, among other reasons, only a small percentage of single-family rentals are listed in their data source (the Multiple Listing Service) and those in MLS are typically more expensive than the average single-family rental.
- Nonetheless, the CoreLogic Single-Family Rent Index closely tracks the authors’ newly devised NTRRI, while the Zillow Index often is higher than the new NTRRI but closely correlated.
In the end, the source of data used by an index has the greatest impact on its comparability to other indices. The authors also conclude that new tenant leases are the most representative of current market conditions.
