The market is heating up across multiple sectors in the economy. Rental housing has yet to be accounted for in the Consumer Price Index (CPI) – what will happen when it is?
Prices of shelter, raw goods, energy and other consumable products have soared during the final stage of the COVID-19 pandemic, particularly in 2021 as market bottlenecks nationally and internationally have developed due to consumers surging out and into purchases of all types.
Talk of inflation is here and the inflationists are heard everywhere. While inflation measures do not typically include asset prices like home values, home prices have soared along with the price of goods and other consumables. Like other goods, real estate pricing for rentals and sales have increased rapidly in the past 12 months.
One thing to understand about inflation is that there are two types: consumer price inflation and asset price inflation. Consumer price inflation includes rental prices since rent is a consumer item. Asset price inflation, on the other hand, includes items people invest in, such as real estate, stocks, bonds and non-consumables – durable items.
Real estate, then, only contributes to consumer inflation calculated into CPI when dealing with the consumable good known as rent.
Will the price of homes, along with goods, fall back; or is this the onset of a permanent adjustment in pricing?
The CPI for all urban consumers increased 5.0% from May 2020 to May 2021. Prices for all items less food and energy (which are more volatile) rose 3.8% year-over-year in May 2021, the largest 12-month increase since June 1992.
Altogether, U.S. consumer prices increased in May at the fastest annual rate since August 2008. This acceleration partially compensates for a few years of below target inflation levels sought by the Federal Reserve (the Fed).
Also in May 2021, year-over-year lumber prices surged astronomically at a 408% annual increase on the peak day of prices. Prices have since come down in June, now a 124% year-over-year change, as of June 18.
In real estate sales, prices are continuing to rapidly increase, fueled by low interest rates and a constrained inventory of homes for sale. As long as the surge of residents flowing out of the cities to suburban and more remote areas continues, this asset pricing trend will continue.
Here in California, the statewide average for low-tier home prices was 16% higher than a year earlier, while mid- and high- tier prices were 15% higher than a year earlier as of March 2021.
As the economy heats up, risks of high asset and consumer inflation levels intensify. Fannie Mae predicts housing to be a strong driver of consumer inflation, with rental housing inflation lasting through at least 2022.
Rents — which are included in inflationary measures — may contribute more than two percentage points to core CPI inflation by the end of 2022, which has the potential to be the strongest contribution since 1990, according to Fannie Mae.
The rental price gains seen today suggest an eventual acceleration in the cost-of-housing inflation from the current rate at 2.0% annualized to about 4.5%, according to the Fannie Mae report. Assuming rental price growth continues at the current pace, consumer inflation will likely move even higher. But personal incomes will need to increase to provide support for these rates of consumer inflation, which is less likely in our present recessionary jobs environment.
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Accounting for asset inflation, what is the trajectory for real estate sales pricing in the years to come?
The peak for real estate prices is approaching rapidly, and the drop will likely be rather dramatic. With the lifting of the foreclosure moratorium, inventory will rise to meet demand as distressed sales return to the market. Buyers will soon become distracted as they return to traveling, buying services, dining out and meeting other objectives on their minds besides the fear of missing out (FOMO) of ownership of real estate like we are seeing today.
This shift in attitudes about allocation of personal wealth will cause sales volume to slow rapidly with strong price reductions of listings for sale following some nine months later – the sticky price syndrome at work again. By mid-2022, we will have seen home prices begin to drop.
Trillions of dollars consisting of multiple stimulus injections flooded the economy in 2020-2021. This injection not spent on consumer goods was saved, infusing capital into the marketplace. This infusion is ending, and so is the urge to spend of both consumer items and capital assets – homes. Only a return to full employment will see the California economy ignite again.
Personal savings rates are up, and momentum is building. Consumers are emerging from the pandemic with heightened animal spirits, telling them to buy now. As people return to their lives as normal, the shock of the pandemic and the distortions it has created in everything, including inflation, will settle.
We will enter the recovery stage of the recession around 2024, when jobs return – jobs that are 1.7 million beneath pre-recession December 2019 levels as of the first quarter (Q1) of 2021 with little advancement in Q2 2021. However, the timeline of this recovery will move forward roughly equal to any further extensions of the moratorium, additional government intervention in the form of stimulus or, most significantly, government-sponsored job creation.
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