Busting the Myth of OER and Inflation

The April 10, 2024, Consumer Price Index (CPI) report noted that inflation increased by an annual rate of 3.5%. This sparked fears that the Federal Reserve might remain “cautious” in its anticipated Effective Federal Funds Rate cuts.

However, Ryan Severino, BGO’s managing director, chief economist and head of U.S. research, pointed out that the inflation rate is skewed higher due to the shelter component. The shelter component is a large part of the CPI. Of that shelter component, owners’ equivalent rent—OER, for short—represents 27% of the shelter index.

In his “Economic Weekly” newsletter, released on April 15, Severino explained why the OER is not a great measure for shelter costs.

#1 – It’s Arbitrary

The OER is a metric released by the Bureau of Labor Statistics. To get that information, the BLS asks homeowners to calculate how much someone might pay to rent their homes. Severino pointed out that “the average homeowner has no idea how to calculate the market rent for their home in any individual period.” Furthermore, when BGO polled CRE professionals, THEY didn’t know. “This makes both the levels of and the changes in OER highly dubious,” Severino commented.

#2 – It’s an Expense that Nobody Pays

Through the OER, the BLS is attempting to determine the cost of shelter – independent of price appreciation. But this is another hypothetical number, Severino said. “It doesn’t represent any real-world expenditure,” he said, adding that other homeowner costs – like utilities – are tracked directly and included in inflation. Two-thirds of those residing in houses are owners – they don’t pay anything close to OER. For the one-third that rents, “rent more directly represents a cost to use a good or service, as opposed to the price of ownership of an asset.”

#3 – Homeownership is an Investment

To this point, most homeowners have a fixed-rate mortgage, which doesn’t increase. Furthermore, while the BLS said that OER captures ownership cost over time (rather than at purchase), “what about the homeowners with no mortgage?” Severino asked. Specifically, 40% of homes in the U.S. have been paid off – no mortgage. “Does their cost end when they have no mortgage?” Severino wondered. “What if they never had a mortgage? What if they own a house and don’t rent it out but also don’t primarily (or never) live in it?”

#4 – There’s a Lag in the Data

The significant problem with the OER is a lag—homeowners are surveyed every six months. Severino noted two problems with this. First, the “BLS simply performs a straight-line interpolation between observations, and we know that’s not how the housing market behaves,” Severino pointed out. Furthermore, “why should we use stale information as a proxy for what’s supposed to be happening today?” he asked.

To Conclude . . .

Severino noted that the OER involves more than “a spirited debate or academic exercise.” Bond yields trended higher after the data release. Additionally, the Fed is making noises that the higher inflation rate will likely further delay cuts to the EFFR.

Overstating inflation can mean a delay in reducing interest rates. And “the longer we delay bringing rates down, the greater the probability of collateral damage in the economy, if not outright recession,” Severino said.