Rising Rents: A Trend That Might Hit Core CPI

Includes: DIA, FRI, QQQ, SPY
by: Paulo Santos

After the real estate bubble popped, a new trend emerged, both because homes lost their skyrocketing allure, because banks got more restrictive with their credit and because of the emergence of a wounded credit-rating army, buying a home got harder and less interesting. The other side of that coin was that renting regained competitiveness.

Not surprisingly, the renting market got hot quite fast, and right now the news are that it’s tighter than at any time since 2001, with the vacancy rate dropping to 5.2% (graph by CalculatedRisk.com).

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Now, the immediate consequence of a tight market, and low vacancies, is higher prices. Not surprisingly, rents have been going up.

But there is another surprise that can be had here. It goes like this: the main component on the CPI, and even more importantly, the core CPI, is something that doesn’t really exist. It’s the owners’ equivalent rent or the rent that homeowners would supposedly pay themselves if they had to pay rent. Now, simplistically, this rent is derived from similar rents paid for similar dwellings. So what happens to the owners’ equivalent rent if rents go up? You guessed it. It goes up as well!

This is not to be taken lightly, since according to Bureau Of Labor Services (BLS), and as can be seen in the CPI Detailed Report-November 2011, Table 1, page 4, Owners’ equivalent rent weights a full 24.9% of the entire CPI, with shelter, also being affected by the rents’ rise, weighting in at 31.9% of the entire CPI. And these weights are even larger when looking at the core CPI (around 25% larger)!


So what does this all mean? It means that core CPI might well continue on an upwards trend in the next few months, making it a lot harder for the Federal Reserve to justify doing any more quantitative easing. Indeed, if the core CPI goes up fast enough it could even make for an inflation scare, though I’m not predicting that (yet).

As an aside, it might make sense to try and study some leveraged apartment REITs, as the rent raising trend might turn out very positive for them. If anyone got ideas to kick start that effort, I am sure willing to listen to them.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.