Rent Catch-Up Is Likely to Keep Inflation High Next Year

Higher rents were a big driver in September’s higher-than-expected consumer price index (CPI) reading. A new report from Goldman Sachs Research finds such inflation could be the source of persistent inflation “stickiness.”

Rent measures from companies like CoreLogic, CoStar, Zillow and Yardi have slowed substantially to an annualized growth rate of 3% in recent months. At first glance, this seems like very encouraging news.

But there is a big difference between those measures and the way the CPI tracks shelter inflation.  While those measures include only new leases, the CPI includes both new leases and continuing leases for existing tenants.  Existing tenants tend to see smaller rent hikes than prospective tenants seeking new leases because landlords are reluctant to alienate and lose them. “The difference is especially important at the moment because market rents on new leases grew very quickly over the last two years and opened a substantial gap with rents on continuing leases,” Goldman Sachs economists wrote—which means rent growth for existing tenants is likely to run hotter as it plays catch up with high (albeit softening) market rates.

GS Research estimates that this catch-up effect boosted continuing-lease rent growth to an annualized rate above 8% in recent months, pushing monthly shelter inflation in the September CPI report to the highest on record—even as the alternative rent measures decelerated.

How quickly the rest of that gap will close is an open question, but it’s likely to take some time. GS Research expects only 3% rent growth on new leases next year, but projects that ongoing catch-up of continuing lease rents will cause CPI shelter inflation to rise from 6.8% year-on-year at present to a peak of 7.5% next spring and to remain at a still-high 5.9% year-on-year growth rate by the end of 2023.

Rent inflation could influence the Fed’s rate-hike plans. That’s because shelter costs have an outsized weight in every measure of inflation central bankers care about, including roughly 40% of core CPI (which excludes volatile food and energy prices).

To date, the Fed’s own forecasts signal that it intends to hold the federal funds rate steady once it reaches a level of 4.5–4.75%, up from 3–3.25% today. But GS economists say they “see some risk that ongoing firmness in these inflation measures could make hiking further than currently planned the path of least resistance.”