Inflation May Have Already Peaked. Here’s What It Means for Multifamily Investors.

Part 2: CPI 

by Max Sharkansky
Managing Partner at Trion Properties

In our early September article, we shared our view that inflation may have already peaked. A week later, the latest Consumer Price Index (CPI) data was released, disappointing many market participants who hoped to see significant cooling in inflation. The Federal Reserve followed up on September 21 with its fifth hike this year–the third consecutive increase of 75 bps.

While inflation is still elevated, we continue to believe it has stabilized and we have passed the highest point. So, what do we make of the CPI numbers? In our view, CPI is effectively inaccurate. The index doesn’t reflect the current economic reality on the ground for its largest component: housing costs. Let’s take a closer look at how the CPI measures housing costs and what it means for multifamily investors.

CPI housing cost component slow to reflect changing market information

Within the CPI’s basket of goods and services, the biggest category by far is shelter. Because of the large weight, movements in shelter costs have a sizeable impact on the overall CPI number. According to the Wall Street Journal, shelter costs in the CPI have been rising at an accelerating pace, accounting for a growing share of the overall inflation rate. The share reached approximately 25% of August’s rate, up from about 20% in February. Shelter costs in the CPI rose 0.7% in August from the previous month, up from 0.5% in July. They rose 6.2% year-over-year in August, up from 5.7% in July.

Do these statistics reflect the economic situation in a way that’s relevant to multifamily sponsors and investors? In our view, no. Industry measures tracking rents of units currently advertised on the open market are slowing from peak levels:

• Zillow Observed Rent Index – Rent growth continued to ease in August, with the typical nationwide rent of $2,090 now 12.3% above last August, down from a peak of 17.2% annual growth in February.
• Yardi Matrix Multifamily National Report – Multifamily rent growth flattened in August. The average asking rent decreased by $1 from the month prior, the first such drop since June 2020.
• Redfin Rental Market Tracker – August data showed rent growth moderated for the third straight month. The national median asking rent was up 11% year-over-year to $2,039, the smallest annual increase in a year.

How can the difference be explained? CPI only gradually incorporates housing market information, causing it to lag contemporaneous market rent measures. The two main components of the CPI shelter category are (1) rent of primary residence, and (2) owners’ equivalent rent of residences (OER). The rent component mainly surveys existing tenants and may not fully reflect the typically larger rental price changes that take place upon tenant turnover.

When experts at the Federal Reserve Bank of Dallas studied the issue, they found:

… Surging house prices feed into rent and OER inflation with a significant delay of 1–1.5 years. This is partially due to the design of the CPI and PCE rent indexes, which are intended to measure monthly changes in rent experienced by typical renters who are unlikely to adjust their leases very frequently. In contrast, rent measures based on new leases tend to move with house prices more instantaneously. Some of these market rent measures have shown signs of cooling in year-over-year rent growth recently, but CPI and PCE rent inflation data lag these rent growth measures by about one year.

What are the implications for multifamily sponsors and investors?

We can see now that the CPI doesn’t quickly capture changes in its largest component. As a multifamily sponsor, it is our responsibility to dig deeper—much deeper—than statistics like CPI when building our financial models. Our job is to know what’s happening on the ground and identify ways to generate outsized returns without taking an outsized risk.

We continue to believe the fundamentals in the multifamily sector are strong. Rent growth rates are coming down from exceptionally high levels, settling in at a more sustainable, organic pace. This normalized rate is still quite attractive and offers more than enough room to underwrite profitable deals. The multifamily sector continues to benefit from favorable demographics, job growth, rising wages, and increased renter household formations. These demand drivers are expected to remain resilient through year-end.

While the CPI may not quickly reflect movements in asking rents, it does influence monetary policy and rate hikes as well as asset prices and corporate and consumer decision-making. For example, the lending environment has become tighter and borrowing costs have moved higher. While these factors can be challenging, we believe they can be adequately managed through diligent underwriting, prudent use of leverage, and hedging. We also believe the modest uptick in cap rates can be appropriately managed through diligent underwriting.

As motivated sellers recalibrate their prices to meet the market, we’re ready and willing to act. In our view, the current moment offers a valuable opportunity to think long term and make strategic acquisitions that benefit our investors.