Inflation: How rent factors into the consumer price index (CPI)

Yahoo Finance's Brian Cheung explains the 'shelter' component of the consumer price index (CPI) in this week's Yahoo U.

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BRIAN CHEUNG: Well, time now for our Yahoo U. And we want to talk about the housing component of the inflation report, but how exactly does the hot housing market bleed into the inflation numbers that we keep blabbering about? So time for a little summer school. Class in in session, and we're talking about headline inflation first.

Again, that big number coming in this morning, 8.5% on a year-over-year basis, is what we're looking at. And indeed, that did show a bit of a slowdown. It's very small from the pace that we had in July-- or rather, in June, which was 9%. But what we're looking at here is the headline figure. This includes everything-- food, energy, housing. But the consumer price index says that roughly a third of this measure is actually on where you sleep for the night, which means that shelter is a major driver of prices-- which begs the question, how does the CPI calculate that?

So shelter, as defined by the government statistics agency that puts this together, is anything that's really a roof over your head. So in addition to your little home, it's also going to include hotels, motel lodging. But what we really care about here is the rent of primary residence and also owners' equivalent rent of residences. And essentially, what that means is that rent is a survey of, well, if you're paying $1,000 or $1,500 a month, that's what when the owner-- when the survey comes around to you.

But owners' equivalent rent of residences is essentially how they calculate home ownership. So if you own your home and you mortgage it out, the survey asks you, if you were to rent out your home without anything inside of it, how much could you get for that? So it's essentially taking homeownership and mortgages and trying to equate it to what a monthly rent might be. And it's also important to remember that those don't factor in homeowners insurance, which, by the way, is broken out separately.

So again, homeownership, not renting-- this one right here-- is actually the majority of shelter in CPI. So let's see what that looks like against the overall inflation story. Blue line here is owners' equivalent rent. The purple line is all items in the US cities. And it's a very interesting trend because the prices have gone up in the overall CPI, as the purple line shows, but the blue line is not at 8% or 9%.

But overall, the story is still the same. It's going up. What's actually very interesting here is the timing of all of this, because the increase that we've seen in the overall CPI began in 2020, but it didn't really begin for owners' equivalent rent until 2021. So what's going on with the lag that lasted almost about a year? Well, the reason is that a hot housing market takes time to bleed into the inflation statistics.

So for example, even though home prices we know for a fact began rising in 2020, it takes time for homeowners to close on the house, actually get into their homes, and then actually get all the things they need inside of them, like fridges. There's a lot of supply chain issues that we've had for the last two years. And homeowners who were asked, well, how much could you rent your home for, may not have caught up with the housing trends on what they could actually rent for until some time after because they were so busy actually trying to move into them.

So all of this is a reason why Goldman Sachs warns that the shelter component of CPI should continue to run hot, even if other price categories fall, which is something to think about as we continue to watch inflation reports through the next few months. And that's it for this week's Yahoo U.