OER / CPI and New York Rentals

Can CPI go lower, regardless of what inflation actually does?

Yes, according to Barclay’s Capital Research (whic we cited earlier). They found Core CPI (also known as Inflation ex-inflation) is being understated for a surprising reason:

1. Core CPI is dominated by Owner’s Equivalent Rent (OER).
2. Existing Home Sales in the NorthEast are outpacing the rest of the country.
3. Existing Home Sales in New York are far outpacing the NorthEast.
4. Manhattan Condos/Coops are far outpacing NY.

The deceleration in OER is directly impacted by the strength in the NY City high end real estate markets — as opposed to homeowner vacancies or rental demand in the rest of the U.S

Barclays writes: "The deceleration in OER has been concentrated in the Northeast, yet the Northeast has the lowest and slowest growing vacancy rate. Meanwhile, the South has the highest and fastest growing vacancy rate, but has the fastest Y/Y pace of growth in OER. These data reinforce our view that vacancy rates have little to do with near-term fluctuations in OER

The chart is quite telling:


courtesy of Barclays Capital Research

Here’s the excerpt from Barclays:

"The rapid rise in 2006 and recent deceleration in OER in the Northeast have been driven, to a large extent, by the New York City metropolitan area, which accounts for roughly 75% of the deceleration in the nationwide measure of OER (Figure 4, left side). New York has also enjoyed a recovery in home sales that is far greater than elsewhere in the Northeast region or in the overall US market (Figure 4, right side). Given the high weight the region has on the aggregate OER measure, the bottom line is that stronger housing demand in the Northeast, and in the New York City area in particular, has been enough to offset the upward pressure on OER from other regions, where housing markets remain soft and demand for rental properties stays strong.

There is a great deal of uncertainty surrounding future movements in OER, especially when one metro area appears to be having such a large effect on the national trend. Because overall OER has decelerated, we think it is reasonable to lower our forecast for core inflation; we now expect the core CPI to rise 2.5% this year (Q4/Q4), down from 2.7%. This is a modest adjustment, and reflects our view that the primary driver of near-term fluctuations in OER is demand for rental properties, rather than vacancy rates. The primary downside risk to our forecast is that the housing markets elsewhere in the country will pick up as firmly as the New York City metro area, leading to reduced demand for rental properties and slower OER growth.

While the OER fluctuations suggest a somewhat lower run rate on core inflation in the months ahead, and this raises the bar a bit for our call for Fed tightening later this year, we ultimately think the growth and labor market data will be decisive. If growth bounces and the unemployment rate continues to decline, we doubt the Fed will take much comfort from a deceleration in OER, especially if that deceleration is caused by a strengthening housing market."

In other words, CPI is expected to be coming lower, regardless of what inflation will actually be doing.


Market Strategy Americas: Economic Outlook
US Economics Research and Market Strategy
Dean Maki, Julia Coronado
Barclay’s Capital May 17, 2007

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