Quirky non-inflation

The BLS Consumer Price Index does not measure the cost of housing/shelter directly by looking at the prices of mortgages, taxes, insurance etc. The cost of shelter is derived by a proxy measurement of looking at Owner Rent Equivilant. Basically the idea is that rents are less sticky and more frequently reported than home sales and we are interested in the cost of housing today and not ten years ago when a home and mortgage was locked in. There is an additional assumption that ownership costs closely correlate with the net present value of rental income streams. Reality bites and this correlation holds true over the long term, but not in the intermediate and short terms.

Rents have been slowly increasing over the past decade while home prices have skyrocketed in absolute, proportional and real terms. Since rents have been increasing at near trend levels, there has not been any significant reported increases of inflation due to shelter while anyone who has bought a home in the past five years would severely disagree with the statement that housing inflation has not occurred. On the flipside, as home prices have fallen in the past eighteen months or so, OER has been relatively stable.

Calculated Risk is passing along what will be an interesting statistical quirk on how housing price inflation will be reported as increasing despite the reality of dropping values:

California Apartment Assn., the state's largest organization of rental property owners, estimates that as much as a quarter of all foreclosed single-family residences are occupied by renters. The number of renters ensnared in the foreclosure fiasco is even larger when duplexes and other multi-unit buildings are factored in.

And the evictions show no sign of abating. Total foreclosures of single-family homes statewide rose more than 400% to a record 31,676 in the fourth quarter from a year earlier, according to DataQuick Information Systems.

Foreclosed homes and rental units are removed from the market for some length of time as banks and MBS trusts don't want to be landlords. That is a skillset past their area of minimal competence and profitability. Units are left empty. Combine renters being evicted due to failure of their landlords to pay the mortgage, individuals who are walking away from their homes, and individuals who are renting today who three years ago would have qualified and taken a NINJA loan to buy a house, the demand for rental units has greatly increased while supply is constrained. Rental prices will increase, and due to how BLS measures housing inflation, OER will increase.

This is not a conspiracy, it is not a cover-up, it is a deliberately chosen statistical quirk that will smooth itself out over the next three or four years, as it is correcting for the underreporting of housing inflation during the bubble years as the rental demand was artificially low, leading to lower prices than a correctly clearing market would have dictated.