Inflation Measures Have Yet To Reflect Slowing Rent Increases, Lagging Indicator Could Impact Policy Decisions
Apartment rent per square foot peaked at an annual growth rate of 10% in early 2023 and has since fallen to less than 5%, according to CoStar. (CoStar)

By Carl Gomez via Costar – CLICK HERE <—- for full article and others like it
CoStar Analytics July 17, 2024

Although Canadian inflation is on its way back to a preferred trend rate of 2%, the journey has been relatively slow, mainly due to specific factors in the Consumer Price Index basket related to shelter. This article applies to the United States as well. The sharp rise in mortgage interest costs, which are entirely the result of past Bank of Canada interest rate hikes, is a major factor that has already garnered significant scrutiny in recent months. However, there is another housing-related contributor that requires similar attention.

That item relates to frothy rental accommodation growth. This component of the Consumer Price Index, which carries a weight of nearly 10% in the overall index, accelerated to an annualized rate of 9% in June 2024 and has yet to show any signs of peaking. As a result, much of the lingering elevated shelter price pressure in the CPI outside of mortgage interest costs can be attributed to this component.

However, there is good reason to believe that the rental component of the CPI may not be reflecting current market conditions, which are already showing signs of a sharp deceleration in rental accommodation growth. For example, CoStar’s census-based estimate of apartment rent per square foot peaked at an annual growth rate of 10% in early 2023 and has since fallen to less than 5% at the end of the second quarter in 2024.

Three specific factors have likely caused this deceleration in rent growth. The primary one is the lack of opportunities for landlords to turn over apartment units. …

Higher vacancy allowed many landlords, especially those with rent-controlled units, to turn leases over at significantly higher “market” rental rates as pandemic restrictions lifted. However, with occupancy now close to 99%, apartment landlords have had fewer opportunities to turn over existing units and increase rents despite considerable potential demand.

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Based on industry anecdotes, some new buildings are having difficulty attracting tenants at these high price points. Consequently, many are lowering rents to attract tenants. Put differently, the scope to support rent growth in new purpose-built apartment rentals with already high rates is limited, given that it is increasingly bumping against income affordability constraints.

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CPI Rent Index is Lagging

Unlike CoStar’s census-based approach to measuring rent growth, the rent index in the CPI is based on a computational model. The model tracks rental payments by sampling renter households drawn from the monthly Labour Force Survey. A more detailed explanation of the CPI methodology is noted here.

To be sure, the resulting rental growth series does a good job of tracking new and existing rental leases and accounting for quality changes in the stock of rental units. However, given the modeled approach, the CPI rent series appears to be heavily smoothed and as a result, may lag turning points in market conditions.

For example, the CPI series did not capture the relatively sharp rise in rental rates caused by tightening vacancies that occurred between 2016 and 2020 until the end of 2019. Similarly, most rental data providers, including CoStar, Rentals.ca, and CMHC, observed that apartment rent growth was accelerating into double-digits in 2022. Only now is the CPI rent index indicating similar growth rates, just at a time when these other data providers are observing rent growth easing.

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