Podcast
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The Role of Rent in Overall Inflation
Important Information:
John O'Trakoun discusses recent trends in the pricing of rental housing and what rents tell us about overall inflation as well as housing markets on the national and local levels. O'Trakoun is a senior policy economist at the Federal Reserve Bank of Richmond.
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Transcript
Tim Sablik: My guest today is John O'Trakoun, a senior policy economist at the Richmond Fed. Welcome back to the show, John.
John O'Trakoun: Thanks, Tim, it's another great day to be "speaking of the economy."
Sablik: Today's show is going to be all about rent — not the musical, but what people pay for housing. You've been studying and writing about rent and housing quite a lot in recent years because of its connection to something the Fed cares very much about, which is inflation. So, why are rents so important to overall inflation?
O'Trakoun: Rents are important to overall inflation because they account for a big chunk of consumption, about 15.5 percent of total personal consumption expenditures and 18 percent of core PCE. This means that what happens with rent prices can really leave an impact on the overall inflation numbers.
Another feature of the rent component of inflation is that it's very sticky. Rents tend to change less frequently than the price of gasoline or eggs, for instance. So, if rents are rising rapidly, they could become a persistent source of upside pressure to overall inflation.
Part of this rent stickiness comes from the fact that when you sign a lease, the rent is locked in for a full year. Or, for musical fans, that's 525,600 minutes.
Sablik: [Pause, then laughter] I feel like I can't ignore that. I don't know how to make a comeback to that, though.
O'Trakoun: Don't worry about it.
Sablik: Is it just rental housing that matters for inflation, or is owner-occupied housing important as well?
O'Trakoun: That's a great question. The answer is that both of them matter. In fact, sometimes I just refer to both categories together as rent, which is what I did in my previous answer.
The way that the statistical agencies measure the market value of housing services consumed by homeowners is through looking at rents from properties that are similar to owner-occupied homes. Homeowners don't actually pay rent, but they are consuming housing services just like renters do, so we use tenants' rents to proxy for the cost of these housing services.
Oftentimes, the two categories will move together in very similar ways, but not always because the types of properties in each category can differ. For tenant-occupied housing, you'll see more multifamily apartment style buildings, while owner-occupied homes will have more single-family units.
Sablik: What role did rents and housing, more broadly, play in the inflation that we saw following the COVID-19 pandemic?
O'Trakoun: Elevated inflation in the pandemic started in spring of 2021. Initially, we didn't see rents do all that much. The higher inflation readings in 2021 were initially attributable to core goods like new and used vehicles, as well as some non-housing core services. Part of this is because of the stickiness of rents. Even though demand was strengthening after the COVID recession, rents were slower to change because many rents were set out in contracts and in leases that were signed before COVID.
It wasn't until 2022 that we started seeing the contribution of rents to inflation start to rise higher than the pre-pandemic readings. That higher pressure to inflation has basically remained above pre-pandemic levels until very recently. In fact, rent inflation remained elevated, even though core goods inflation was already dissipating in 2022 and 2023 and had turned negative by 2024. That's the flip side of the stickiness of rent inflation. It can take longer to get going, but it can also stick around longer after price pressures in other spending categories have already moderated.
Sablik: In addition to telling us something about current inflation, rents can also provide a signal of future inflation trends. Why is that?
O'Trakoun: The official rent indexes in inflation reflect the average rent across the country. But there are two types of renters out there. There are those who are already existing renters and renewing their leases, and those who are new renters who are signing new leases. Existing renters who are renewing their leases tend to see slower changes to their rent. Sometimes, the rent for next year's lease is exactly the same as the rent you're paying this year, for instance. We see larger changes for people who are signing new leases. They're either brand-new renters or they're moving apartments and found a new one. These people tend to pay market rents.
Over time, existing rents tend to catch up to where the market rents are. By looking at today's market rents, you can get a sense of where overall average rents are headed in the future. Research looking at this issue has found that various measures of market rents tend to lead official rent indexes by about a year.
Sablik: What are rental markets signaling about future inflation now?
O'Trakoun: Market rents are indicating a positive outlook for rent inflation, at least from the Fed's perspective of getting back to 2 percent.
My favorite measure of market rents is Zillow's Observed Rent Index. When you look at the three-month annualized growth rate of this index, they basically returned to pre-pandemic levels in 2024 and they stabilized there since then. Given the one-year lag between the Zillow index and the official rent index, that means we should be returning to pre-pandemic growth rates this year.
In fact, that's already happened. If you look at the three-month run rate of the official tenant rent index, it's basically back to pre-pandemic growth rates already. It's likely to stabilize there based on what market rents are doing. The 12-month growth rate of the official rent index is a touch high, but it's headed in the same direction.
Sablik: Talking about market rates, do variations in local rental markets complicate this picture at all?
O'Trakoun: Well, the Fed sets interest rates which affect the whole national economy. So, our policymakers put a lot of focus on the national rent index. However, rent conditions in local markets provide important context for how different communities are experiencing rent inflation. We can see that, even though rents are moderating nationwide, some areas of the country still are seeing upside rent pressures.
Local data can also provide an important way of checking some of our assumptions. For example, I said that it takes about a year for market rents to flow through to official rent indexes. We can use local data to check out whether that relationship holds across different geographies, comparing market rents in a particular metro area to the official rent index for that metro area. I took a look at this in a recent Richmond Fed Macro Minute blog. It looks like that relationship seems to hold for local data as well as the national.
Sablik: Yeah, and we'll definitely include a link to that piece and some of the other ones that you've written recently on this topic.
What do rental market conditions look like in the major metropolitan areas across the Richmond Fed's Fifth District right now?
O'Trakoun: The three-month growth rates of market rents in D.C., Baltimore, and Charlotte have fallen below the national average. However, we also have areas where rent growth remains higher than the national average, including right here in Richmond where the three-month annualized growth rate is a full percentage point above the national average.
These geographic differences reflect things like different rates of normalization after the COVID-era rent increases. They also reflect different local economic conditions. For example, the D.C. area is seeing impacts of reductions to the federal workforce. That's also affecting Baltimore as well.
Sablik: What will you be watching with rents over the second half of this year?
O'Trakoun: I'll continue to track market rents to see if they hold at pre-pandemic levels. If they start to weaken below that benchmark, it could be a sign of broader demand weakness.
On the other hand, they could rise as well. We've seen multifamily housing starts this year slow down compared to 2022 and 2023. That could lead to tighter supply of multifamily housing in the future. Depending on what the economy looks like, that tight supply could lead to more rent pressure. The first place we'd see that is in the market rents.
Sometimes people will look at the rent-to-home price index. Right now, that looks kind of high. Some people will use that as guidance for where rents will go or home prices will go in the future. But it's hard to know which one of those two is going to do the adjustment.
Sablik: Well, thanks for joining me today, John.
