REconomy Podcast: Deflation in the Housing Market? Let Us Explain.

In this episode of the REconomy podcast from First American, Chief Economist Mark Fleming and Deputy Chief Economist Odeta Kushi discuss how inflation in owner-occupied housing is measured and why an argument can be made that the long-run trend in housing cost has been deflation, not inflation.

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In this episode of the REconomy podcast from First American, Chief Economist Mark Fleming and Deputy Chief Economist Odeta Kushi discuss how inflation in owner-occupied housing is measured and why an argument can be made that the long-run trend in housing cost has been deflation, not inflation.


Odeta: Hello, and welcome back to another episode of the RE conomy 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, I've got a question for you. What does a gallon of milk cost you these days?

Mark: Hi Odeta. That's an interesting question. $3.50. But I think ,why are you asking?

Odeta: Well, because today we're talking about inflation. And in 1913, that gallon of milk costs about 36 cents a gallon. And inflation is broadly defined as a sustained and generalized increase in the prices of goods and services in the economy. But of course, we're housing economists. So today, we're not just talking about inflation, we're talking about the shelter component of inflation. And that might not be what you think. The Bureau of Labor Statistics calculates the shelter component of the CPI by trying to capture rents on renter occupied housing and imputed rents on owner occupied housing, which really makes you wonder why imputed rents? Why can't we just use house prices?

Mark: Wait a second, I'm not even quite sure what an imputed rent is. And I'm really confused. So let's start back at the basics. First of all, the CPI or the people who measure the price indices for inflation, actually consider housing as an investment, not as a consumption item. So the value of a house or whether or not you buy a house and purchase it or improve that housing unit, that's investment activity, that's not consumption. So then you ask yourself the question, Well, how do you consume housing every day, every night as shelter the roof over your head? And so it's the shelter component, where the shelter benefit that you get from housing, whether a renter, or a homeowner that really matters when calculating inflation. For homeowners that cost of shelter? Is this implicit rent or imputed rent that the owner occupant would have to pay if they were renting their home? So the BLS asks you, if someone were to rent your home today, how much do you think it would rent for a monthly amount? Unfurnished and without utilities? This is called the owners equivalent rent of the primary residence or O-E-R.

Odeta: Yeah, we'll be saying ORE, a lot. So that's the owners equivalent rent, that's what we're referring to. Okay, so then that means that using house prices would actually be capturing the investment piece of housing, rather than the consumption of shelter? Well, I can easily answer how much I pay in rent today. But Mark, I'm curious, how much would you write your home for today?

Mark: But Odeta That's the problem. I have no idea how much I would rent the home for. I'm a home owner. Thankfully, luckily, these days, right? Yeah, I'm given what we've talked about you and I and the travails of becoming one these days. But for homeowners today, how would they know what the rent or how much they could rent it for? If I were a renter, I would clearly know how much I rent my home for how much a three bedroom two and a half bath two and a half thousand single family home goes for in terms of rent. But homeowners don't really know. Why would they? They're not participating in the rental market.

Odeta: That's a really great point. And it's also important to note that the shelter component of the CPI that reflects this oh er the owners equivalent rent, it actually hasn't moved around very much. The year over year growth in the owners equivalent rent in April was about 2%, which is the same as it was in the previous three months. And this OER represents about 24% of the overall CPI, while the rent of primary residence accounts for about 8% of the CPI. So overall, shelter prices account for approximately 1/3 of the headline CPI and about 40% of the core CPI. That's a lot.

Mark: Well, I think it's safe to say that getting the rate of shelter inflation correct is pretty important in measuring the overall inflation and it might be beneficial to sort of explain this concept that it's about a basket of goods. So one of those goods is the good called shelter that you receive or the service called shelter. Another good is that gallon of milk. Another one is how much you spend on food in general gas in general, all the things we buy and sell. That's what makes up the CPI. But in that basket. The component associated with shelter is one of the largest if not the largest, depending on how you're measuring it.

Odeta: Definitely and this oh era, oh er measure is intended to impute rental value, as we were saying by asking homeowners how much they would rent their home for. It's a really tough question as we just discussed, and some research has actually shown that homeowners tend to underestimate rent appreciation During expansionary periods, and over estimate it during session periods. So I guess it begs the question, should owner occupied shelter inflation be higher today? Is the shelter CPI just a lagging indicator that we can expect for it to increase in the months to come? I mean, what's going on?

Mark: Well, if we can't rely on homeowners to know what their imputed rent is, then what can we do Odeta?

Odeta: Maybe it's about house buying power.

Mark: House buying power? You mean that thing we've been talking about for years now? And in every podcast. And in every podcast, house buying power, house buying power? That's exactly right. We have to sort of discuss what it means to pay rent every month. And while it's obvious if I'm a renter, it's who the landlord I send the check for the rent to that's pretty straightforward. Of course, renters when asked in the surveys know exactly how much rent that's not the issue. But the homeowner, who does he pay rent to? Oh, we could argue that maybe they pay rent to the mortgage company. This is how I get the shelter of my house, I have a mortgage, I pay an amount every month, my principal plus my interest. For the sake of argument here, we'll throw in the taxes and the insurance in your escrow account. Isn't that my equivalent of my monthly payment to someone like rent for a renter? So why not think of this in the construct of how much one pays per month as the rent? Otherwise, we're talking about things like discount rated net present value, see prior episode on what that's all about? Let's skip all I have right now and just focus on what do I pay per month.

Odeta: This may be a bit oversimplified, but a quick check on house buying power holding income constant over time, shows that we've actually been able to buy more home since 2019, on a year over year basis, thanks to falling mortgage rates. So that's actually deflationary. Now, let me just clarify that we're not suggesting that this is the right measure of inflation and owner occupied housing, nor that the BLS immediately changed their methodology. But we do think it's worth thinking through another way to capture owners rent, that isn't just asking them a question that they don't know the answer to.

Mark: Then just to be clear, when we say deflationary, we're really talking about the concept of buying power. Even when you classically think about inflation, it's still buying power. If a gallon of milk goes up in price, you can buy less, that's inflationary. So in this case, because house buying power is allowing us to buy more, that's deflationary. So it would seem that when we ask people what they might think it's probably not as good as deriving it from the data.

Odeta: Well, I am partial to using data. I also want to highlight one of the reasons that we're talking about this. And it's because of the Fed, the Fed looks at inflation, when it states its longer run inflation goals. You know, obviously, that's very important, but the Fed is actually using a different measure of inflation called the personal consumption expenditures, inflation or PCE, while the federal government uses the consumer price index, or CPI. That's been the topic of our conversation today. Now, the equivalent concept to owners equivalent rent in the in the CPE is called imputed rent, and it represents less of a share in the PC than in the CPI. Are you lost in the acronyms yet? But the concept of imputed rent is similar. So Mark, have you figured out how much you would rent your home for today?

Mark: Well, I'm still working on it. But I think if they do ever ask me, I'll probably aim low. Or even better. I'll just take a look at the data.

Odeta: Not a bad idea. So the takeaway from today's episode is that owner occupied housing inflation is measured by asking the homeowner how much they would rent their home for. A question which many homeowners don't have the answer to. That's because they want to treat housing as a consumption rather than an investment good. Now, this measure hasn't moved around very much for the last few months. So we ask why not look at how much home one can by holding their income fixed. Once we do that we find that homeowners can afford more home today compared to one year ago, thanks to falling mortgage rates. Thank you for joining us on this episode of the REconomy podcast. Be sure to subscribe on Apple, Google, Spotify, or your favorite podcast platform. You can also sign up for our blog at And if you can't wait for the next episode, follow us on Twitter. It's at @odetakushi for me and @mflemmingecon for Mark. Until next time.

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