A Funny Thing Happened on the Way to Getting CPI Shelter Under Control

Previous Articles

I have written numerous article about the future of CPI shelter starting with this in May 2023 Forecasting the Future of CPI Shelter | LinkedIn. The first forecast I made for CPI shelter was in this article Forecasting CPI Shelter Part 2 | LinkedIn which incorporated CPI rent data through May 2023 then provided a forecast and confidence intervals through May 2025. I provided an updated forecast with data through August 2023 and showed how the actual CPI rent tracked versus the forecast from May 2023 in this article Tracking CPI Rent Forecasts | LinkedIn. What I believe sets these articles apart from others is that they include updated forecasts and show how actual CPI shelter has tracked versus previous forecasts.

Rent Growth Metrics

The relationship between CPI shelter and real time rent measures is best understood graphically which is depicted below. See that Zillow, Costar, and Apartmentlist year over year rent growth started their dramatic increase at the beginning of 2021 and peaked a year later at the beginning of 2022. Conversely, the peak of the year over year CPI shelter growth peaked at the beginning of 2023, approximately one year later. It is this relationship that enables us to forecast CPI shelter growth. This relationship was the basis of a National Bureau of Economic Research paper, “The Coming Rise in Residential Inflation” by Marijn A. Bolhuis, Judd N. L. Cramer, and Lawrence H. Summers which forecasted both CPI Owners’ Equivalent Rent Inflation and CPI Rent Inflation.

Observations

It helps to see that CPI Owners’ Equivalent Rent and CPI Rent of Shelter largely walk in lock step so while they are separate components of Shelter CPI, they are not materially different. Because of this, I generally provide only a forecast for CPI rent. Also notable is that in 2019, when inflation was at the Fed’s target level, CPI shelter was in the mid 3% range. Therefore it is not necessary for CPI shelter to be at 2% to get overall inflation back to 2%.

Tracking the May 2023 Forecast

We can start by comparing our May 2023 forecast to actual CPI rent growth. See that through August 2023 the actual CPI shelter lined up almost perfectly with the point forecast. Since then, actual CPI rent has moved to the upper confidence bands and in November 2023 breached the upper 75th percentile band. If we look back to our Zillow Observed Rent Index, which is the variable I am using to forecast CPI rent, we see that over the past three months the year over year rent growth has remained around 3.3%. This flattening of year over year rent growth also shows up in the Costar data and the Apartmentlist data although at different annual rates. I will admit that this flattening of real time rent has come as a slight surprise to me as the pipeline of apartments under construction is the largest it has been since the mid-1980s and because of this, I expected annual rent growth to continue to fall. This unexpected flattening in rent growth is what has caused CPI rent to be higher than originally forecast in May of this year. The original forecast of CPI rent reaching 2% in June of 2024 now appears overly optimistic.

Updated Forecast

The updated forecast shows a much more gradual descent in CPI rent than the May 2023 forecast. The May 2023 forecast showed CPI Rent expected to hit 2% in July of 2024 whereas the current forecast shows it expected to hit 3% in May of 2025 then largely flattening from there. The flattening of the real time measures of year over year rent growth has caused the expected return to 2% CPI rent, and hence CPI shelter, to be pushed off indefinitely. This should come as no surprise as the Zillow Observed Rent Index has flattened in the mid 3% range. This does not imply that overall inflation will not be back to 2%, but instead that the other components of inflation would need to be below 2% to offset the above 2% inflation in CPI rent as had been the case in 2019 as mentioned earlier.

Uncertainty

The reason for including confidence intervals in the forecasts is because there is uncertainty associated with forecasts. As we have seen with the forecast from May of this year, an abrupt change in the real time measures of rent growth can be a cause for deviation from the point estimate of CPI rent. Yet just as rent growth has surprised to the upside, it is possible in the future that it will surprise to the downside or continue to surprise to the upside, greatly impeding the Fed’s fight against inflation.

Model Updates

I will continue to track the real time measures of rent and update my forecasts as more data becomes available. But the current forecast indicates that the Fed’s fight against inflation will continue.