Introduction to Housing Inflation
Housing costs make up about 35 percent of the Consumer Price Index (CPI), which means that shelter inflation plays a big role in overall inflation dynamics. Recently, housing costs have had a significant influence on inflation trends, making the relationship between market rents and CPI shelter inflation very important. Market rents refer to what new tenants pay when moving into a dwelling.
Understanding the Lag in CPI Shelter Inflation
Researchers have found that CPI shelter inflation responds slowly to changes in market rents. There are three main reasons for this lag. First, about 60 percent of rental dwellings have 12-month leases, which means rents can’t adjust to market changes until the lease is renewed. Second, when leases are renewed, landlords often smooth out rent increases for continuing tenants instead of immediately adjusting to current market rates. Third, the way the CPI shelter index is calculated creates an additional lag in measured inflation. The index is derived by comparing rents in a given month to rents six months earlier.
The Role of Landlords in Rent Smoothing
Landlords play a key role in the slow response of the CPI shelter index to market rent changes. When leases are renewed, landlords typically don’t raise rents to match current market rates. Instead, they smooth out rent increases, which means that continuing tenants don’t see immediate changes in their rents. This smoothing of rent increases is a key factor in the CPI shelter index’s slow response to market rent changes.
Modeling CPI Shelter Inflation
To better understand the relationship between market rents and CPI shelter inflation, researchers have developed a model that predicts CPI shelter inflation based on market rent movements. The model uses monthly data from 2015 to 2025 and employs the Zillow Observed Rent Index (ZORI) as a measure of market rents. The researchers also adjust for differences between ZORI properties and CPI-measured properties.
Key Parameters in the Model
The researchers use a variety of data sources to estimate three key parameters that affect measured CPI inflation. These parameters include the fraction of tenants who have month-to-month rentals, the tenant mobility rate, and the fraction of the change in market rent that landlords pass through to continuing tenants when they renew their lease. The researchers estimate that about 35 percent of tenants have month-to-month rentals, the tenant mobility rate is 1.8 percent per month, and landlords pass through about 21 percent of the change in market rent to continuing tenants.
Insights from the Model
The researchers’ model sheds light on the lagged responses of CPI shelter inflation to market rent movements, particularly during periods of sharp change in rents. The model suggests that rent smoothing for continuing tenants is essential for explaining the observed data patterns. This means that landlords’ decisions about how to adjust rents for continuing tenants play a big role in shaping the CPI shelter index.
Conclusion
In conclusion, the relationship between market rents and CPI shelter inflation is complex and influenced by several factors, including lease duration, rent smoothing, and the way the CPI shelter index is calculated. The researchers’ model provides valuable insights into the lagged responses of CPI shelter inflation to market rent movements and highlights the importance of rent smoothing for continuing tenants. Understanding these dynamics is crucial for making sense of inflation trends and developing effective policies to address housing affordability and inflation.
