Rising Rents Risk U.S. Inflation as Fed Restraint Questioned
For all the attention given to almost $4-a-gallon gas, the biggest threat to containing U.S. inflation may be the shift away from homeownership, which is pushing up the cost of leases across the nation’s 38 million rented residences.
Shelter represents about 40 percent of the consumer price index excluding food and energy and accounted for almost one quarter of the 1.3 percentage point rise in April. That share has grown as falling home prices shake Americans’ confidence in housing as an investment.
Federal Reserve Chairman Ben S. Bernanke and his colleagues say they will hold interest rates at record lows for an “extended period,” based on an assessment that slack in the economy from 9 percent unemployment will help subdue core inflation and any threat of accelerating prices likely will be “transitory.” Not everyone agrees with that judgment.
“They should have looked at rents,” said Maury Harris, chief U.S. economist in New York at UBS Securities LLC, whose team at UBS was the most accurate inflation forecaster over 2009 and 2010, according to Bloomberg calculations. “They’re putting too much weight on the ‘slack is all that matters’ theory. It matters but, for heaven’s sake, it’s not all that matters.”
Housing has become “a contributor to inflation, and it continues to rise,” agreed Bruce McCain, chief investment strategist at the private-banking unit of KeyCorp in Cleveland, with $22 billion in assets under management. That’s partly why he’s advising clients to look at “specifically, a heavier mix of equities, and maybe the use of TIPS to mitigate the effects inflation could have over 10 years or longer.”
Investor expectations of rising prices in the next decade, as measured by the spread between Treasury Inflation Protected Securities and nominal bonds, have fallen to 2.28 percent from 2.66 percent on April 11, the year-to-date high.
“When you look at the longer-term portion of a bond portfolio, consider pretty carefully the ravaging effects that inflation could have,” McCain said in an interview. He estimates that rents have accounted for about 1 percentage point of the last decade’s 2.4 percentage point rise in prices and soon may revert to or overshoot this trend.
“The worse it gets for apartment rentals, the more you’re going to see that number adding to the overall inflation rate,” he said.
Harris calculates that prices excluding food and energy have risen at an annual rate of 2.1 percent so far this year based on the consumer price index. The Fed’s preferred gauge, the Department of Commerce personal-consumption expenditure index, rose 1 percent in April from a year earlier. Including all items, it increased 2.2 percent.
Policy makers are “misreading the inflation, period,” Harris said in an interview. “If you have a healthy rate of core inflation, you don’t have any business having the federal funds rate under 25 basis points. That’s ridiculous.” The Fed cut the target rate for overnight loans among banks to near zero in December 2008.
Confidence in homeownership has been battered in the wake of the subprime-mortgage crisis, which pushed housing prices down 33 percent since July 2006, based on the S&P/Case-Shiller index of property values in 20 cities. Prices in these cities fell in March to the lowest level since 2003 -- led by Charlotte, North Carolina, and Minneapolis, showing that housing remains mired in a slump almost two years into the economic recovery.
Seized in Foreclosure
More than 3 million homes have been seized in foreclosure since the start of 2008, according to RealtyTrac Inc., and the rate of homeownership has fallen to 66.4 percent, the lowest since 1998, data from the Census Bureau show.
About two-thirds of Americans now think buying a home is a safe investment, down from 83 percent in 2003, said government- supported mortgage financier Fannie Mae in a national survey released May 11.
The percentage of AvalonBay Communities Inc. (AVB) residents moving out to purchase a residence fell to 12 percent in the first quarter, down from 15 percent in the last quarter of 2010 -- “the lowest level since we began tracking this data,” Chairman and Chief Executive Officer Bryce Blair said in a April 28 analysts’ call.
AvalonBay is the second-biggest publicly traded U.S. apartment owner with more than 50,000 units in the Northeast, Mid-Atlantic, Midwest, Pacific Northwest and Northern and Southern California. First-quarter funds from operations climbed 18 percent to $93.5 million from a year ago as rising demand helped it increase rents, the Arlington, Virginia-based company said in an April 27 statement.
“Job growth, particularly among young workers, is driving higher rental demand, while new supply remains muted,” Blair said in the statement. “We expect fundamentals will continue to accelerate during the year.” AvalonBay stock has risen 16 percent this year.
U.S. apartment rents climbed 5 percent in the 12 months through April, according to research company Axiometrics Inc. Effective rents in the first quarter, or what tenants actually paid, rose in 75 of the 82 markets tracked by data provider Reis Inc., which said the average was up 2.5 percent from a year earlier to $991 a month.
“Landlords have a couple years of runway to have pricing power over their tenants,” said Anthony Paolone, an analyst at JPMorgan Chase & Co. in New York. He recommends that investors looking to profit financially from the increases should consider a trio of real-estate investment trusts: Palo Alto, California- based Essex Property Trust Inc. (ESS), UDR Inc. (UDR) in Highlands Ranch, Colorado, and Equity Residential (EQR) in Chicago.
UDR has risen 8.8 percent since January, Equity Residential climbed 17 percent and Essex jumped 18 percent. The Standard & Poor’s 500 Index increased 5.8 percent in the same period.
The boon for landlords is a burden for residents like Alexander Shevlyagin, a 25-year-old Seattle computer-software manager, who said he was shocked to learn his rent is rising to $1,305 a month from $935 and his free parking space will cost $100.
“My building manager told me, ‘Hey, we’re almost at full occupancy,’” Shevlyagin said. “He said he signed the same place I have on a different floor for the new rates, so someone thinks that this is reasonable. Knowing what I’m paying right now, I don’t consider it reasonable.”
From January until October 2010, rents helped hold down overall inflation as the year-over-year change in shelter -- mainly rents and what owners would receive if they rented their homes -- was negative, according to data from the Bureau of Labor Statistics.
Then the component turned positive in November. Rental yields, or rents relative to home prices, will climb this year to the highest level in more than 20 years and remain elevated for as many as four years, predicts Paul Dales, senior U.S. economist in Toronto for Capital Economics Ltd.
“I’m sure it’s something the Fed is watching, but I wouldn’t be too surprised if they haven’t factored in such a rise,” Dales said. “It’s possible the Fed may be surprised there.”
At their April meeting, Fed officials projected core inflation for 2011 between 1.3 percent and 1.6 percent; their estimate for 2012 was 1.3 percent to 1.8 percent.
“With resource slack likely to diminish only gradually over the next few years, it seems reasonable to anticipate that underlying inflation will remain subdued for some time, provided that longer-term inflation expectations remain well contained,” Fed Vice Chairman Janet Yellen said in a April 11 speech in New York.
While rents weren’t mentioned in the minutes of the April meeting, the Fed’s April 13 Beige Book report, an anecdotal survey of economic conditions, was peppered with stories of rising costs.
In Manhattan, studio-apartment leases “continued to climb and were up more than 10 percent from a year ago.” In Boston, apartment “rental-rate increases persist,” and contacts in Chicago reported “developing strength in the rental market and a corresponding pick-up in conversions of condominiums into apartments.”
The Fed may be falling behind the curve, said Joel Naroff, president of Naroff Economic Advisors in Holland, Pennsylvania. Rising rents are “a risk to the core, which is the important number if you’re looking at Fed policy,” he said, estimating the rate could top 2 percent by the end of this year.
“It’s clearly a cost-of-living issue, especially as people who were in the homeownership market are winding up in the rental market,” he said.
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