Housing inflation has remained stubbornly higher than market expectations since rental inflation spiked in 2022. Looking ahead, we believe not only that housing inflation is behind us, but also that rental inflation will run much below the pre-COVID norm.
Recent history
After a housing supply glut contributed to the global financial crisis (GFC) in 2008, the U.S. housing market only slowly normalized from 2012–2019. New housing unit construction remained below the pace of household formations, which helped reduce overcapacity, and both home price appreciation (HPA) and rental inflation (owners’ equivalent rent, OER) advanced at a slow and steady pace.
However, from 2020 to 2021, pandemic housing demand surged due to extraordinarily low interest rates, a shift in consumer preference for owning a home, large fiscal transfers, and strong economic growth. The post-GFC decade of underbuilding coupled with the surge in demand drove home price appreciation to about 20% annually on average in major metro areas – a pace not seen even during the pre-GFC housing boom (home price data from S&P Cotality Case-Shiller indices).
The dynamics of rental inflation
As home prices rose at this unprecedented pace during the pandemic, similar-sized rental inflation was just a matter of time. Residential unit prices are closely linked to rents, because 1) investors in rental properties demand a certain yield on their investments, and 2) as housing prices rise relative to incomes, buying a home becomes less affordable, driving rental demand higher. With some lag (about 12 months), the new lease rents increased in line with housing prices, according to U.S. Consumer Price Index (CPI) data.
However, rents do not rise uniformly. About 20% of renters move each year, per the U.S. Census Bureau. A spike in new lease rents, therefore, quickly and completely affects about 20% of the renter population, while the remaining 80% who renew their leases tend to see increases much more gradually. Landlords typically prefer to keep existing tenants because of the upfront costs associated with new tenants and loss of rent during vacancy. Hence, the net change in rent occurs slowly; it takes about four additional years for renewals to catch up to new tenant rental rates (see Figures 1 and 2).
Figure 1: U.S. rents remain well above pre-COVID levels
Figure 2: U.S. rental inflation has largely stabilized following post-COVID swings
Data suggest the time needed for lease renewal rates to catch up to new tenant rents was the main reason why OER was stubbornly higher for longer. Another contribution was the significant influx of humanitarian immigration into the U.S. from 2022–2024; most of these new households were limited to the rental market due to credit availability.
Where are U.S. housing prices now?
The pendulum has swung the other way. Housing affordability had declined as interest rates rose in response to inflation and due to strong home price appreciation relative to wage growth seen during the pandemic. Now, although U.S. GDP growth remains fairly strong, real wage inflation has cooled, and wage levels have not fully adjusted to the now much higher costs of purchasing and maintaining a home. Trump administration immigration policies have slowed new household formations, and a normalization in remote work has reduced the urgency to trade up for space. Finally, a surge in new multifamily building in the wake of the pandemic is now delivering fresh supply into the tepid demand market. New supply has especially weighed on rents in Sun Belt cities.
Over the past 12 months, this confluence of factors has led to flat home price appreciation. In real (inflation-adjusted) terms, HPA is actually negative – a positive development because it should improve affordability over time.
At the same time, rental inflation is decelerating fast. Zillow’s new lease data show rents rising at a rate of 2.1% annually, which is almost 50% lower than the pre-COVID norm. Single family rental inflation as measured by Cotality is even lower, growing below 1% annually for the first time since the GFC. The gap between new lease rental rates and renewal rental rates has also largely normalized, alleviating another persistent source of inflation within the rental market.
The outlook for rental inflation doesn’t look much different. Although the pace of new housing supply has already slowed, data also show rental homes are sitting on the market longer (see Figure 3), which may put pressure on landlords to further discount rents for both new and renewal leases in the months ahead.
Figure 3: Estimated average number of weeks on market for U.S. rental homes
Bottom line
The rate of U.S. rental inflation is likely to turn a corner this year, going from stubbornly elevated to surprisingly low – even dipping 30% to 50% lower than pre-COVID norms. With rental inflation (rents and OER) making up just over 30% of the core CPI index, a 1 percentage point deceleration would reduce core CPI inflation by 0.3 percentage points. This, along with fading cost pressures associated with tariffs plus higher productivity reducing the labor costs of output, should give the Federal Reserve comfort that inflation is heading sustainably back to its 2% longer-term target.
In recent years, OER proved stubbornly high. This year it may prove stubbornly low, giving the Fed room to further normalize interest rates.
