The conventional wisdom is that inflation causes higher interest rates which in turn causes lower housing prices. We are now seeing an interesting phenomenon where housing prices continue to stay high and in some markets head even higher with interest rates double what they were during the pandemic. Is inflation now increasing house prices? What does this mean for the future of rents and house prices?

Why care whether inflation is increasing housing prices and rents?

The reason it is important to understand the drivers of housing inflation is that it will indicate where housing prices head from here. In this cycle the housing market is remaining robust; this is the opposite of what we would expect to see. In the consumer price index housing makes up over 1/3 of the metric so as housing costs stay high inflation in turn will remain high.

The conventional wisdom is that inflation should cause a reset in home prices along with rents and in turn slow down inflationary pressures associated with housing. This is not happening and instead rents, and housing prices are increasing.

Why are rents remaining high

Household expectations about the change in the cost of rent have risen sharply from last year, with rental costs expected to increase by 1.5 percentage points to 9.7% for the next year, according to a survey by the New York Fed released Monday. Why are rents staying high

Less affordable rental units: it is not possible in many areas to build affordable housing rental units that are market rate (not government subsidized) due to land costs, new construction codes, etc… the numbers do not work
Higher insurance and taxes: Higher taxes and insurance are added to the rental costs, these new expense are being passed through in the form of higher rents.
Higher labor/maintenance costs: just like everything else is feeling inflationary, labor costs for maintaining rentals and higher material costs are also flowing through to higher rents
More renters: More families are remaining tenants longer term as the math to buy a property doesn’t work with high interest rates. This increased demand further helps drive rental prices higher.

Inflation is now driving housing prices as opposed to the inverse

As you can see from the four items listed above, each of the items above are driven by inflation from interest rates, building costs, unaffordable purchase options, etc… In essence the higher for longer mantra of the federal reserve is creating a higher for longer scenario in housing due to inflationary pressures now driving housing prices and rents higher. This is not a good situation to be in as there are limited options to resolve this chicken vs egg dilemma without major damage.

Correlation between rents and housing prices

It is important to note that there is a strong correlation (not one to one) between rents and housing prices, high housing prices filter into rents and vice versa. If housing prices were falling substantially, we would also see rents start to fall as the tradeoff between renting and owning narrows and vice versa.

In past cycles there would be a quick run up in rates (like 2008) which would lead to a reset in housing prices and in turn rents. In this cycle housing prices have continued increasing (with a small blip the end of last year) while rents are also staying constant or increasing which is what I would expect from the correlation between the two.

Something must break for inflation to stop driving real estate inflation

We are in an interesting situation as the only way to bring inflation down is to bring rents and housing prices down, yet, the wait and see attitude of the federal reserve is actually embedding more inflation into housing creating a huge problem. With inflation now driving rents and in turn housing prices higher the federal reserve must break something in order for inflation to fall. The current path is not working as we can see from the recent inflation numbers.

Long term still be a reset in prices

Even though we are seeing inflation now keeping rents high and in turn helping to keep housing prices high, eventually something in the economy will break and the circular pattern will be broken as there is no way to get inflation under control without focusing on the biggest metric, housing. Ultimately we will see housing prices fall, but this could be another year from now as the higher for longer mantra continues to work through the economy. When housing prices fall or rents begin falling (whichever happens first), the other will also begin to reset.

Summary

The federal reserve has created a circular inflationary environment with inflation now driving both rents and housing prices higher. This occurred as inflation was not dealt with years ago when everyone but the fed knew we had an issue. We are now seeing this play out with inflation running 50% higher than the 2% target. Unfortunately with housing the largest contributor to the inflation metric, the only way to solve the inflation problem is to ultimately keeps rates high long enough to ensure there is a downturn in housing.

On paper this all sounds great to “ease” the economy into a soft landing. In reality, the soft landing will be close to impossible based on past inflationary events which means that housing prices and rents are in for a reset if the federal reserve is serious about getting inflation back to its 2% target.

Additional Reading/Resources

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Glen Weinberg personally writes these weekly real estate blogs based on his real estate experience as a lender and property owner. I’m not an armchair reporter/writer. We are an actual private lender, lending our own money. We service our own loans and own commercial and residential real estate throughout the country.

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Fairview is a hard money lender specializing in private money loans / non-bank real estate loans in Georgia, Colorado, and Florida. We are recognized in the industry as the leader in hard money lending/ Private Lending with no upfront fees or any other games. We fund our own loans and provide honest answers quickly. Learn more about Hard Money Lending through our free Hard Money Guide. To get started on a loan all we need is our simple one page application (no upfront fees or other games).

Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in Bloomberg, Businessweek ,the Colorado Real Estate Journal, National Association of Realtors Magazine, The Real Deal real estate news, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.

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