Why the CPI Doesn't Capture Rents Accurately
The Consumer Price Index has many uses, but its reliance on significantly lagged housing data regularly causes headaches for those in the multifamily industry.
- How Does the Consumer Price Index Work?
- The CPI’s Highly Weighted, Lagging Rent Data
- An Example Highlights the Difference
- Does This Mean the CPI Is a Bad Inflationary Indicator?
- 3 Ways of Measuring Changes in Rents for Investors
- Private National or Market Rent Surveys
- National Average Home Prices
- Local Multifamily Investment Brokers
- Conclusion
- Related Questions
- Get Financing
Every month, the Bureau of Labor Statistics, or BLS, releases a new report on the consumer price index, or CPI. The CPI is the most widely used measure of the cost of goods and services in the U.S. economy.
It is established through a survey of goods and services available to the public. The CPI gives a measure of how the prices of these goods and services have changed over time.
How Does the Consumer Price Index Work?
The CPI includes a wide range of goods and services, such as food, gasoline, travel, clothing, and housing. Data collection is conducted in 87 major metropolitan areas around the United States. The CPI is widely used as a source for identifying inflation or deflation across the country.
The CPI’s Highly Weighted, Lagging Rent Data
The CPI does a relatively good job of measuring the cost of many consumer goods and services, but it falls significantly short when it comes to housing costs. The CPI does include housing, but it does so through rental costs, not home values. While this does make sense on a level — housing prices are anything but stable, after all — the way it collects data for rents is problematic and often at odds with insights from multifamily industry experts.
The CPI counts the money paid by a resident to a landlord, adding in utility costs. In the case of affordable housing where the government subsidizes rents, the CPI will also capture those subsidies.
This means that the CPI only captures in-place rents. While there is some value in that, this creates a significant lag compared to using asking rents for available units. Furthermore, the CPI gives housing costs (known as its “shelter category”) a full one-third weight of the index. This means that inaccurate data will drastically alter the CPI’s end result.
The consumer price index looks at a sample of approximately 50,000 renters across the country, regardless of when they signed their existing lease agreements. As most multifamily leases run for a one-year period, this can lead to some problems. The largest amount of leases are signed in the late spring or summer. If you’re using in-place rents for a December CPI report, you’re relying on old data. And that may not reflect the reality of the market, state, or country, even en masse.
An Example Highlights the Difference
I’ll walk through this with an example using rents in Las Vegas. In July, let’s say in-place rents were equivalent to $1,600 per month, after a significant increase in rents following the pandemic. Because the CPI is compiled using in-place rental data every six months, these same data points would be used for a November or December report.
But asking rents during this same period may have changed significantly. In Las Vegas, let’s say asking rents in November dropped to $1,550 from the aforementioned $1,600 peak. That’s a fairly hefty decrease, sure, but it’s not impossible — especially going into a recessionary period. This 3.125% decrease wouldn’t be captured fully until long after the leases were signed.
For these reasons, it’s generally far more useful to rely on asking rents, as they indicate real-time changes in the housing market. It’s not a perfect metric, of course — just because a market has higher asking rents doesn’t mean many people are paying them — but it does capture useful trend information.
Does This Mean the CPI Is a Bad Inflationary Indicator?
Not at all. It just means the CPI isn’t the best indicator for housing costs. The Federal Reserve, of course, is aware of this lag issue, but there’s little they can do except to understand that it’s an imperfect measure.
Considering the impact of interest rate increases on cap rates, and it’s really important for multifamily investors that the Fed fully grasp these issues.
3 Ways of Measuring Changes in Rents for Investors
Although the Fed tends to rely more on the CPI than any other metric for inflation — whether for housing or general goods and services — those investing in the multifamily sector have several better options. All in all, though, use one data set at your own peril. Ideally, a blended, nuanced approach is key to understanding how rents are moving.
Private National or Market Rent Surveys
There are a number of good reports out there, whether from a brokerage firm like Cushman & Wakefield or CBRE, or from investment platforms like Costar or Yardi Matrix. These will often give indications of rent growth (sometimes only on a year-over-year basis, but often on a monthly or quarterly basis).
National Average Home Prices
Home prices are an important component of a housing market. By assessing overall housing prices and looking at changes in price, you can get a pretty good idea of the health of a market. While single-family housing trends aren’t always mirrored by multifamily shifts, it can be a good way to assess how much of a difference exists between renting and buying.
The CPI does look at owned housing but uses a figure called “owners’ equivalent rent,” which instead looks at the cost for someone to rent the property they live in. Understandably, it’s not the most accurate metric out there, so using actual property price changes can be very useful instead — even if the data may shift quickly and significantly.
Local Multifamily Investment Brokers
An experienced local broker can offer insights as to the changes in a housing market, especially looking at how a market’s development pipeline and supply across the quality spectrum matches with renter demand.
Conclusion
The Consumer Price Index provides an overall look at the cost of goods and services in the U.S., but it can be an inaccurate measure of housing costs due to its use of lagging rental data. What’s more, it has little application at the local level, which is where most multifamily investors are focused. For an accurate picture of housing costs, it is better to look at more forward-looking indicators, whether using national rental market reports or changes in housing prices.
Related Questions
What is the Consumer Price Index (CPI)?
The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by consumers for a market basket of goods and services. It is widely used as a source for identifying inflation or deflation across the country. Data collection is conducted in 87 major metropolitan areas around the United States and includes a wide range of goods and services, such as food, gasoline, travel, clothing, and housing.
How does the CPI measure rent prices?
The CPI measures rent prices by looking at the money paid by a resident to a landlord, including utility costs. It captures in-place rents, meaning the rents of those who have already signed a lease agreement. The CPI gives housing costs a full one-third weight of the index, so inaccurate data can drastically alter the CPI’s end result. Source and Source.
What are the limitations of the CPI when measuring rent prices?
The Consumer Price Index (CPI) has several limitations when measuring rent prices. Firstly, it only captures in-place rents, meaning it is a lagging indicator compared to using asking rents for available units. Secondly, the CPI gives housing costs a full one-third weight of the index, meaning inaccurate data will drastically alter the CPI’s end result. Thirdly, the CPI looks at a sample of approximately 50,000 renters across the country, regardless of when they signed their existing lease agreements. Lastly, the CPI has little application at the local level, which is where most multifamily investors are focused.
How does the CPI affect multifamily financing?
The Consumer Price Index (CPI) is an economic indicator that measures the average change in prices of goods and services over time. It is used to measure inflation and deflation in the economy. Inflation can have an impact on multifamily financing, as it can affect the interest rate on the loan. When inflation is high, interest rates tend to increase, which can make borrowing more expensive. This can lead to higher cap rates for multifamily properties, as the cost of capital increases.
Sources:
What other methods can be used to measure rent prices?
In addition to private national or market rent surveys, investors can also measure changes in rent prices by looking at national average home prices. Home prices are an important component of a housing market, and by assessing overall housing prices and looking at changes in price, you can get a good idea of the health of a market. While single-family housing trends aren’t always mirrored by multifamily shifts, it can be a good way to assess how much of a difference exists between renting and buying.
The Consumer Price Index (CPI) also looks at owned housing, but uses a figure called “owners’ equivalent rent,” which instead looks at the cost for someone to rent the property they live in. This metric is not the most accurate, so using actual property price changes can be very useful instead — even if the data may shift quickly and significantly.
For more information, please see this article from Multifamily.Loans.
What are the benefits of using alternative methods to measure rent prices?
The benefits of using alternative methods to measure rent prices include more accurate and up-to-date information, as well as insights into the local housing market. Private national or market rent surveys, such as those from Cushman & Wakefield or CBRE, or from investment platforms like Costar or Yardi Matrix, can provide indications of rent growth on a monthly or quarterly basis. Additionally, local multifamily investment brokers can offer insights as to the changes in a housing market, such as how a market’s development pipeline and supply across the quality spectrum matches with renter demand. Source