Why are rental costs increasing? Ask the Fed

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The Federal Reserve has just raised interest rates the most since 1994 to curb inflation, but its policy could end up fueling, not squashing, a key component of consumer inflation: the cost of rent.

Here’s why: As mortgage rates climb to an average of nearly 6% and house prices continue to rise, all-in payments are increasing by hundreds of dollars a month. A growing number of US consumers are being priced out of their homes. Instead of buying, more of them feel financially compelled to rent, which drives up that price as well.

“Mortgage payments have outpaced rents on many homes,” Taylor Marr, Redfin’s deputy chief economist, said earlier this year. “While renting has become more expensive, for many Americans this year, it is now more attractive than buying.”

Redfin data shows that average rents in the U.S. rose 15% year over year in May and surpassed a record $2,000, with asking rents falling nearly 50% in Austin, Texas, and in Cincinnati, Seattle and Nashville are up more than 30%. Unless the supply of apartments and houses increases, these rents will remain high and even rise, unless there is a major economic downturn that causes people to find roommates and live in less space.

A big part of the problem is a housing shortage in the US after years of under-construction relative to demand. And there are signs that higher interest rates are discouraging homebuilders from starting new projects, exactly the opposite of what is needed to bring costs down. US new home construction fell in May, with housing starts falling 14.4% to the lowest in more than a year.

From a broader perspective, developers have been particularly reluctant to make big investments since 2008 because shareholders haven’t rewarded them for it. Instead, stockholders have prioritized prudent balance sheets and cash returns from housing companies decimated in the 2008 financial crisis.

Or as Conor Sen, a Bloomberg Opinion columnist, succinctly put it in our Twitter Spaces discussion on Friday, “It’s a really tough thing because we think homebuilders are in the business of building houses, but on a specific one Point, they just become an investor base that says, ‘All I care about is going back. I don’t really care about the business you’re in.’”

Without further constructs, there is still theoretically a possibility for the Fed’s monetary policy to lower prices. There is a general belief that high mortgage rates will ultimately drive down values ​​and parts of the US housing market are beginning to cool off to some degree. There are fewer sales and more price reductions in listed homes.

But the slowdown hasn’t hit valuations materially yet, and it probably won’t for years to come, as many homeowners bought when mortgage rates were low and are easily weathering that part of the economic cycle. In addition, there was less speculation, and investors put more equity in the properties in times of scarce supply. This will exclude many families from owning their own home and force them to rent.

Meanwhile, higher rents will make it harder for key inflation metrics to start falling. Accommodation costs account for more than 30% of the consumer price index. While the Fed looks at various metrics, including one that gives a lower weight to rent, consumer inflation is important in determining inflation expectations, Fed Chair Jerome Powell noted at his press briefing on Wednesday after announcing the decision to raise interest rates by 75 basis points.

The prospect of higher monthly housing costs after major Fed rate hikes is an uncomfortable and troublesome notion. It underscores the bluntness of the tool the Fed is using to address the nuanced and multifaceted dynamics of inflation. Ultimately, the only way to consistently dampen price increases without the cooperation of the physical world—in this case, building more houses—is to drive a downturn deep enough to fundamentally change people’s living standards, at least in the short term.

In the meantime, until such a drop in demand occurs, Fed policy will continue to tighten the screws on everyone, especially those on the bottom end of the income spectrum, most of whom rent their homes.

This column does not necessarily represent the opinion of the editors or of Bloomberg LP and its owners.

Lisa Abramowicz is the co-host of Bloomberg Surveillance on Bloomberg TV.

More stories like this are available on bloomberg.com/opinion

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