A Closer Look: Why Housing Inflation Is Still Running Hot

August 1, 2023

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“Shelter inflation,” as it’s called in the Consumer Price Index (CPI) and the Personal Consumption Expenditures price index (PCE), is the government’s measure of housing costs. It’s a major driver of today’s inflation numbers, representing about a third of the total value of the basket of goods and services covered by the CPI.

But what is included in “shelter”? Many people assume the government is measuring home prices here, but that’s not the case because homes are also seen as investments. To separate out the investment value and isolate the cost of the “shelter” service, the government looks instead at what renters are paying plus what homeowners would pay if they were renting their own dwellings (in part through looking at what renters are paying for similar units).

Since the CPI and PCE track price changes for all housing units, both new leases and renewal leases are included. New leases typically see larger price changes than renewal leases, which tend to adjust more gradually.

Because of this, when new leases are running hot, a large gap can develop between new and renewal leases. And since the hike in new leases doesn’t hit most households right away, the CPI and PCE don’t reflect the full increase in market values immediately.

The Bureau of Labor Statistics (BLS) itself acknowledges that the housing numbers in CPI and PCE reports lag behind actual market rents and home prices by about a year. This delay in registering market prices makes shelter inflation a “lagging indicator.”

In the past few years, as renewal rents have risen to catch up with new rents, the spike in market prices has gradually made its way into the government’s inflation numbers. Now, as prices moderate, the slowdown is taking time to fully show up, too.

Our colleagues in Goldman Sachs Research recently shared their views on how this gap between new and renewal rental prices may affect the outlook for the official housing inflation numbers:

The outlook for shelter inflation depends crucially on the size of the remaining gap between rents for new and continuing tenants. As the gap closes, shelter inflation should moderate further.
Recent data from the BLS suggests that the gap closed completely in the first quarter of 2023. If this is true, it would suggest shelter inflation should fall below the pre-pandemic pace very soon. However, our Research economists suspect that the BLS measure overstates how much the gap has closed.
Other measures of new-lease rent growth with larger sample sizes look a little different from the BLS figures and lead our colleagues to estimate that the gap between new- and continuing-lease rents is now around 3.25%, down from a peak gap of 7.5%.
Official shelter inflation has already slowed from a peak monthly annualized rate of over 10% to 5.5% in the most recent PCE report.
A growing supply of multifamily housing should help keep new-lease rent growth subdued. GS Research’s rent inflation model projects a 3% annualized increase in new-lease rents over the next couple of years. They also expect the gap between new- and continuing-lease rents to continue to close, as continuing leases continue to grow at a faster pace. Based on these factors, our Research colleagues expect shelter inflation to slow to a 5% annual rate by December 2023 and 3.75% by December 2024.

The index for shelter was the largest contributor to the monthly CPI all-items increase in June, accounting for more than 70% of the increase. But the slowdown in the official shelter measures is now well underway, and their contribution to overall inflation is likely to continue shrinking.

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