Here's an interesting perspective on today's inflation, mortgage rates and San Francisco Bay Area real estate, and how they all relate to a curious little data point called owners' equivalent rent.
The latest Consumer Price Index (CPI) report was higher than hoped, meaning no rate-cut by the Fed in the immediate future. This hit the bond markets hard, which in turn caused mortgage rates to skyrocket more than a quarter percent (+28 basis points or 0.28%) — one of the largest single-day rate increases we've seen. From Matthew Graham of Mortgage News Daily, "Hair splitting aside, there just aren't many past examples of rates rising more than a quarter point in a day. Before covid, it had happened one other time in the past decade."
In a separate post, Graham highlights that markets are now pricing in expectations for the first rate-cut coming in September (certainly not March as many predicted at the start of the year).
Really this post is inspired by Paul Donovan, the Chief Economist of UBS Global Wealth Management. In his recent newsletter — Lies, damn lies, and comparing inflation statistics — Donovan explains the discrepancy between EU and US inflation rates.
"European inflation has slowed to 2.4%, while US consumer price inflation is 3.5%.
The reality is that while the Euro area had 2.4% y/y inflation in March, the US also had 2.4% y/y inflation in March—using the US harmonized inflation measure. US harmonized inflation adopts the same method as Europe to calculate inflation—it is a like-for-like comparison.
Current differences between headline US and European inflation are thus more about calculation methods than inflation realities. Headline US inflation is dominated by the fantasy price of owners' equivalent rent, and owners' equivalent rent is not allowed anywhere near either European or US harmonized inflation data."
So, what is this 'fantasy price' anyways?
Owners' Equivalent Rent (OER) is an economic concept that estimates the rental value of owner-occupied homes. It represents the amount homeowners would pay to rent their own homes or the rent they forgo by not renting them out. This measure is used to assess housing costs and inflation, as it attempts to reflect changes in the cost of housing services for homeowners.
Sounds reasonable enough on paper. But in Donovan's words, "OER pretends that homeowners rent their own homes from themselves." And, referring to inflation back in October, "The fairy tale of owners' equivalent rent, where statisticians pretend people pay themselves an ever-rising monthly rent to live in the houses they own, was the main driver of higher prices."
With so many US homeowners locked into an historically low-rate mortgage, many pay a fraction of OER as their true out-of-pocket housing expenses. This goes doubly so for California homeowners who benefit from a reduced property tax basis from Prop 13 and Prop 19.
LEARN MORE: Prop 19: How to Save on Property Taxes When You Move
What can you do about this discrepancy in real-world economics and economic data-nerdery? Not a whole lot, unless you have some serious pull at the U.S. Bureau of Labor Statistics which tracks the CPI… But it's something to keep in mind as you consume the economic news. Markets are jumpy. No economic report is infallible.
Meanwhile, the SF real estate market is off to a solid start in the spring season. If you have real estate questions or are ready to explore your options buying or selling, reach out and let's chat. At no obligation, we are happy to discuss your personal situation and see if we’re a good fit to work together. Contact us today.
