First American

The REconomy Podcast™: Why Rent Growth Has Likely Peaked and What that Means for the Housing Market

In this episode of the REconomy Podcast™ from First American, Chief Economist Mark Fleming and Deputy Chief Economist Odeta Kushi explain the economic forces driving rent growth, why rent growth is likely decelerating, and the implications for the real estate investors and the housing market.

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Listen to the REconomy Podcast Episode 50:

“Rent growth is likely to slow as rental household formation slows and new supply comes to the market. But it will likely stay positive as the purchase market has priced out a lot of potential buyers. From an investor's point of view, cap rates will likely trend a bit higher through the end of the year.” – Odeta Kushi, deputy chief economist at First American


Odeta Kushi - Hello, and welcome to episode 50 of the REconomy podcast, where we discuss economic issues that impact real estate, housing and affordability. I'm Odeta Kushi, deputy chief economist at First American and here with me is Mark Fleming, chief economist at First American. Hey Mark, happy 50th episode. Can you believe it?

Mark Fleming - Hi, Odeta. Fifty episodes. To think we started this podcast in 2020, in the middle of a pandemic, and here we are two years later, still going strong. And, it's almost as old as I am, at this point, scary thought. It's been an absolutely wonderful experience. And I am just so happy to have you as a co-host for it.

Odeta Kushi - Well, right back at ya. And, I mean, we did have to find a productive way to replace all of those economic watercooler chats in the office when we went remote, and thus REconomy was born.

Mark Fleming - Productive, you say? Well, that remains to be determined.

Odeta Kushi - We tried, we tried, we tried. But I digress. So, what are we talking about on this special 50th episode, Odeta? Well, we're going to talk about a topic that lives rent free in my mind.

Mark Fleming - I sense a witty play on words there. Let's think about this for a second. I take it we're discussing rents today, then?

Odeta Kushi - Correct. We usually cover the residential real estate market, but buying and renting are often viewed as substitute goods, so this is a great topic. It's also a great time to define this Econ 101 term. A substitute good, which is, just as you might think - two goods are considered substitute goods if the products could be used for the same purpose by the consumers. And then the opposite of a substitute good is a complementary good. These are goods that are dependent on one another. So the classic example of a complementary good is cereal and milk.

Mark Fleming - That's right and renting and homeowning are substitute goods, because in either case, the service you are provided is shelter. You either choose to rent a place to live in, or you choose to buy that place to live in. But, either way, you get that service of shelter from that home.

Odeta Kushi - So, how would you measure whether people are choosing to rent or own? And, by the way, we did touch on this a little bit in our last episode when we discussed one potential reason why rents are rising, but it does bear repeating.

Mark Fleming - Yes, economists do like to measure things, and in particular, we look to household formation data for this, the US Census Bureau defines a household as including, quote, the related family members and all the unrelated people, if any, such as lodgers, foster children, wards or employees, who share the housing unit.

Odeta Kushi - Yes, but the definition continues. And there's an important exception, the definition continues to say, quote, a person living alone in a housing unit or a group of unrelated people sharing a housing unit, such as partners or roomers, is also counted as a household, the count of household excludes group quarters end quote.

Mark Fleming - Yes, group quarters. So that's saying, if you're living in a college dorm with a bunch of roommates, then you're not considered a household. And, if you live with your parents, you're considered part of your parents household.

Odeta Kushi - That is right. And the rise and fall of households has implications for the homeownership rate and one minus the homeownership rate, otherwise known as the rentership rate. The way I like to explain this is by talking about what's driven the rise and fall of the rentership rate over time. So therenter ship rate is simply the number of rented households divided by the total number of rented and owned households. Now, prior to the Great Financial Crisis, we saw owned household formation at the expense of rental household formation, which drove down the rentership rate.

Mark Fleming - Yes, but what we've seen in the aftermath of the Great Recession is growth in rental household formation, that's your millennials aging out of their parents homes, yes, but they actually are doing that, and their college dorms as they graduate. In both of those cases you're not considered a household or you're part of your parents household. The decline in the homeownership rate from 2005 to 2015 was not because of foreclosures and an overall decline in the number of homeowning households as many had thought, but because of a big demographic surge in the number of renting households. But, things have changed again, starting in 2016, we have once again begun to see the homeownership rate increase at the expense of the rentership rate once more. Millennial renters wanting that substitute good.

Odeta Kushi - Yeah, I'm one of those renters that transitioned into homeownership, so I fall into that change. Excellent point. Yes. Now there were some disruptions in data collection over the pandemic, but our hunch is that at the beginning of the pandemic in 2020, a lot of, especially younger households, moved back in with parents or roommates. The decline in rental household formation likely prompted the pullback in annual rent appreciation. But, as the world started to open back up again wages began to pick up, roommates decoupled, and people moved out of their parents homes, a lot more rental household formation putting more pressure on rental demand and causing rents to increase. According to the Zillow Observed Rent Index, national annual rent growth peaked at just over 17% in February of this year, but has since decelerated to about 11% in September, so still high and positive, but decelerating from that peak. So, what do you think is driving that deceleration and rent growth?

Mark Fleming - Well, as economists, we always have to say, on the one hand and on the other. Let's start with one hand first. One reason that it is tied to household formation is that given all of the economic uncertainty, new rental household formation, just like in the uncertain days of the early days of the pandemic, may be slowing again. In other words, if you're thinking of moving out of your parents’ home, or decoupling, as you say, from your roommate who doesn't do their dishes in that shared apartment, you're basically choosing to stay put instead, it's too uncertain of a time to make such a big decision. Less rental shelter demand, less pressure on rents.

Odeta Kushi - And there are reasons to think that rent growth will continue to slow, but for reasons unrelated to household formation, and that's supply. The number of multifamily units under construction is the highest it's been since 1973. And that will eventually be net new multifamily supply added to the housing market, which will put some downward pressure on rents.

Mark Fleming - That's right. Household formation is the demand side of the equation and supply is the other. But there's one other. Maybe this is the third-hand factor that we touched on at the top of the episode.

Odeta Kushi - I guess the substitute good - buying a home.

Mark Fleming - Newsflash, it's pretty expensive right now with rates hovering near 7%.

Odeta Kushi - It sure is. And rising interest rates, alongside high prices, mean some would be buyers are priced out of the purchase market. And, in fact, according to our First-Time Home Buyer Outlook report from earlier this year, we found that affordability for potential home buyers was down significantly from one year ago. And this data is from Q2. As rates have increased even further, the affordability picture has likely worsened, so that data found that the median US renter, who can also be considered the median potential first time home buyer, could afford 35% of the homes for sale nationally in April of 2022, down from 54%, one year earlier.

Mark Fleming - So the rental market is definitely benefiting from this lack of affordability in the purchase market because it keeps renters from transitioning from that renter household to that home-owning household. There is, dare we say, shadow homeownership demand keeping demand for renting high.

Odeta Kushi - Right, potential home buyers priced out of the purchase market are in a tight spot, though, as high rents could cut further into their ability to save up for a down payment.

Mark Fleming - That's a good point. But, given everything we've discussed, there's also a good chance that we will see that rent growth slow.

Odeta Kushi - That's right. I am curious, though, what does all of this mean for multifamily investors?

Mark Fleming - Yes, though, the owners of all these apartment buildings? Well, it's a good thing that we came out with a new proprietary report just this month that helps to answer this question. Sorry, listeners a little First American Econ self promotion here.

Odeta Kushi - Yeah, it's almost like I knew that. That's why I asked the question. Yes, the inaugural First American Multifamily Potential Cap Rate Model or PCR.

Mark Fleming - That's a mouthful.

Odeta Kushi - That is a mouthful. That's why we say PCR. The multifamily PCR model estimates a potential national multifamily cap rate based on commercial real estate and macro-economic market fundamentals, including multifamily transaction volume, multifamily mortgage flows and annual changes in, none other than, renter household formation. Care to provide a refresher on what a capitalization or a cap rate is, Mark?

Mark Fleming - It's the 50th episode and so I should be used to being the one who has to do the Econ-splaining. Get it? Econ-splaining? Okay, cap rates, simply put, relate the income-generating potential of these multifamily properties to their values, providing the investors with a measure of the potential return on their investment. For example, if a multifamily property purchased for $100,000 generates an income of $10,000 a year, it has a cap rate of 10%.

Odeta Kushi - And we know that in 2021 and into 2022, strong investor demand has kept multifamily cap rates near all-time lows as they have better prices in an effort to beat out the competition. But our model indicates that multifamily cap rates may be headed higher. And the reasons are some of the factors we've already mentioned. While multifamily fundamentals remain strong, a deceleration in multifamily rent growth and price growth is already underway. And, while unemployment remains low, wage growth has not kept pace with the rising cost of living and consumers appear to be running through some of the excess savings that they accumulated during the pandemic.

Mark Fleming - And, confronted with inflation-driven higher prices, fewer people can afford to cover their rent expenses, which is decreasing the demand to lease apartments. And, as we already discussed, ongoing economic uncertainty may discourage new demand for rental units by keeping those roommates from decoupling and thereby also decreasing new rental household formation. This is beginning to play out in the leasing market as third-quarter multifamily leasing activity has slowed meaningfully. Leasing activity is facing headwinds. And the combination of slowing rent growth and higher interest rates is beginning to slow the price growth component as well.

Odeta Kushi - So right now our model is showing a multifamily PCR that is slightly higher than the actual multifamily cap rate, which implies that market fundamentals support a slightly higher cap rate than the prevailing market rate. And we expect the multifamily PCR to begin to increase towards the end of 2022. You can find out a lot more about this model on our Econ Center at So, just to recap this episode, because there's a lot in here, rent growth is likely to slow as rental household formation slows and new supply comes to the market. But it will likely stay positive as the purchase market has priced out a lot of potential buyers. From an investor's point of view, cap rates will likely trend a bit higher through the end of the year.

Mark Fleming - And aside from the obvious reasons why all of this matters, you know shelter, pretty big expense for most people. It also matters to the Fed's monetary policy decisions. Shelter is the largest component of the Consumer Price Index, making up about 30% of overall inflation. And, in recent months, it has been one of the largest components keeping inflation high. By virtue of how they're measured, though, shelter inflation lags observed rental and house price increases by as much as six-to-12 months. The rent deceleration that we're seeing today will likely not show up in those inflation measures for some time to come.

Odeta Kushi - Somehow, we always bring it back to the Fed.

Mark Fleming - These days, it's always about the Fed

Odeta Kushi - The Fed and inflation. All right. Well, that's it from us today. Thank you for joining us on this episode of the REconomy podcast. If you have an economics-related question you'd like us to feature on a future episode, you can email us at We love to hear from our listeners. And, as always, if you can't wait for the next episode, you can follow us on Twitter. It's @OdetaKushi for me and @MFlemingEcon for Mark. Until next time.

This transcript has been edited for clarity.