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Goodbye to hyper-low interest rats for homebuyers; hello to even higher rents. People are staying put, which means we may not see meaningful change in the housing market next year. What does this mean for the overall inflation picture? Dr. Orphe Divounguy, Senior Economist at Zillow, joins Tony to discuss the housing market from an inflationary standpoint. 

The Housing Market Could Send Inflation Through the Roof

Tony Roth, Chief Investment Officer, Wilmington Trust Investment Advisors

Dr. Orphe Divounguy, Senior Economist at Zillow

TONY ROTH: This is Tony Roth, your host of Capital Considerations and CIO of Wilmington Trust. We’re here today with a terrific guest and we have an important topic, which is the state of the housing market. And so, if you have shelter, if you’re seeking shelter, or even if you don’t have any form of shelter but somehow against all odds you still participate meaningfully in our economy and are interested in where inflation’s moving, housing prices, and equivalent prices for rents are very important in understanding the trajectory of inflation.

So, a really important topic to talk about today and our guest is, as I mentioned, a terrific guest on the topic. His name is Dr. Orphe Divounguy, and he is a Senior Economist at Zillow. His job essentially is to help the firm understand market developments that shape the housing market and the narrative that Zillow might have at any given moment. Dr. Divounguy joined Zillow after previous work focusing on labor markets, housing, and using various quantitative methods to evaluate the housing market and he’s also an experienced podcaster himself. He cohosts a podcast called Everyday Economics, great title, and like ours his podcast focuses on ways that the global markets and economic phenomena affect the world around us. And so, Dr. Divounguy, thank you so much for joining today.

ORPHE DIVOUNGUY: Oh, thanks for having me.

TONY ROTH: So, we could start at so many different places and I want to really get into understanding where the housing market is, where it’s going. I want to talk about the rental market. There are various stats in the marketplace that tell us that affordability of housing is at an all-time low given how high housing prices have moved and given how quickly mortgage rates have increased. Really hard for people to go out and buy a house, even if you’re fairly well-off. Unless you’re paying in cash, it’s probably not going to be a pretty sight in terms of monthly payments. And rents continue to actually climb from these levels.

So, a tough housing market and one that really impacts inflation. So, before we jump into it, I think we should level set and make sure everybody understands who Zillow is. We’ve all heard of Zillow, but not everybody necessarily knows that Zillow’s role is in the real estate system in this country.

So, Orphe, maybe just, level set for us Zillow. Who are you guys? What do you guys do?

ORPHE DIVOUNGUY: The role of Zillow is to try to make home a reality for more and more people. Our mission is to help people get home. And so, we provide a marketplace. We want to be as transparent as possible. We are helping buyers, sellers, and agents to get to their destination as painlessly as possible, because we know buying and selling a home is extremely complex and so we want to help.

TONY ROTH: Sometimes, I’ll catch my wife looking at Realtor.com for chalets in someplace like Malibu or maybe Hawaii. But I know it’s more fantasy than reality, unfortunately. But you guys do the same thing? Could she just as easily be looking at Zillow or is your business model different?

ORPHE DIVOUNGUY: She could easily be looking at Zillow to see, houses of all types.

Dreaming is part of the process. You start with dreaming and then you start to think about what can I do to get into the home of my dreams, right?

TONY ROTH: Terrific. So, let’s get into the housing market. As I mentioned, housing prices, while they’ve started to come down, they’re really high. In your estimation, why did the housing market become so elevated? Was it primarily due to the hyper-low interest rates that we had or was it that so many people wanted to have a second home or a different home due to the pandemic? What drove the, that vast increase, because it’s different than the great financial crisis where there were so many speculators buying two, three, four houses. That wasn’t as prevalent. So, what is it?

ORPHE DIVOUNGUY: It’s a combination of factors. Even before the pandemic we had about a decade, I want to say 15 years of under-building, right? We were not building enough units to house everyone in the United States. And so, that was the, I think that was the first big issue is that builders, for a number of factors, maybe related to the global financial crisis, were not building as many homes as we needed to build in the U.S.

And then, you had a demographic shift, you know, Millennials and Gen Z coming of age, starting families. So, this demographic shift also boosted the demand for housing. Then, you also had low interest rates. So, we know that low mortgage rates reduce the financing cost, the cost of financing a home. But and then you had the fiscal stimulus due to the pandemic, which boosted incomes. Americans were basically getting all that income and then were told not to go out and spend it. And so, savings increased tremendously.

And so, you had, you know, all of those factors. Stock market wealth is another factor. I mean we had stock market records broken before and during the pandemic and all those factors combined helped to push up the demand for housing. And, unfortunately, builders were caught flat-footed, right? So we, without building, keeping up with the demand, the increase in demand prices soared.

TONY ROTH: So, you’re not talking just about starter homes. You mean starter homes, luxury homes across the board, just not enough new supply coming into the market?

ORPHE DIVOUNGUY: Absolutely, absolutely. You have, you know, on every single price tier you saw an increase in demand and competition, extreme competition at every level, bidding wars, a lot of wealth coming into the United States as well, right, pushing up at the high end, prices at the high end. We saw this rapid increase in prices throughout the pandemic and recently, I think back in October or November, the Fed chair came out and said, look, you know, maybe we made a mistake in not raising rates fast enough, and we saw this reversal in Fed policy that pushed mortgage rates very rapidly, I think at the fastest speed in recorded history from roughly 2.5% to over 7% today.

TONY ROTH: Yeah. And also, I'd throw in longevity as another factor. Lifespans in the U.S. are actually increasing.

ORPHE DIVOUNGUY: That's right.

TONY ROTH: And ironically, the pandemic, that sort of sloped upwards a little bit. The second derivative has actually accelerated, if you will, of longevity in the U.S. and that’s also probably keeping people in their homes. So, when you look at all of that and you talk about that reversal, Orphe, we’ve had a total reversal of monetary policy. You just described it for us. Mortgage rates of 7% from two-and-change. And you also have total reversal of fiscal policy, which is a drag on the economy now. So, why aren’t we seeing home prices come down faster or are we seeing them come down?

ORPHE DIVOUNGUY: What we expected was a much faster deceleration and maybe even a slide, a faster slide in home prices. But home values are kind of sustained at pretty high levels. Fed policy is a blunt instrument, right?

So, what we saw is the increase in mortgage rates not only pushed out many potential home buyers, right, so the demand side, but also the supply side because it makes financing new investments, building more expensive. And for existing homeowners, it means they’re not willing to trade low rates for higher ones, because look, 71% of sellers end up buying again.

TONY ROTH: That's fascinating. So, I could be trading up, I could be trading down, or I could be trading sort of horizontally into a new geography. But if I'm going to have to trade into a new home that’s going to have my monthly payment skyrocket because either the home prices have gone up since I last purchased and/or rates have clearly skyrocketed, it’s going to lock me into where I am.

ORPHE DIVOUNGUY: That's right.

Very little incentive to go back on the market right now. In fact, new listings are down 16% when compared to this time last year. Demand fell by more than supply. You know, my estimates are around roughly 32% decline in demand.

So, inventory is going to increase because of the demand falling by more than supply means inventory will increase. But it’s not increasing fast enough, right? So, it’s not – when you look at month supply, the, you know, how fast it would take to sell the housing stock today at today’s sales pace, it’s still much below than it was before the pandemic. Of course, there are some exceptions.

The housing markets that were extremely expensive in the Austins and Seattles, those are places that are seeing rapid inventory increases and faster price declines. But most of the country is still not, in terms of inventory, still nowhere near the pre-pandemic level.

TONY ROTH: Well, that’s interesting. I would’ve thought that the, some of the markets that were very hot, whether they were driven by the SALT repeal and migration of folks out of high tax jurisdictions, two places like Austin or Florida, I would’ve thought that those jurisdictions would’ve stayed pretty high. That's not what you're seeing?

ORPHE DIVOUNGUY: No, not at all. I think that what happened was as people moved and demand surged, builders responded, and builders responded in a major way. You look at places like Austin, you know, you had a surge in homebuilding. You had a lot of housing that was started. Because of supply chain troubles, you had a lot of housing that were started in 2021 that are just being completed today. And they’re coming on the market at a time where demand has pulled back. And so, you’re seeing a surge of inventory in some of these areas and that is what’s driving the slide in house prices in those expensive markets, that of course combined with the fact that they were really expensive already. And so, a low affordability means that the places that are most expensive are going to see the biggest slide in demand.

TONY ROTH: Where are we in the cycle around new home construction with developers? Because you talked about the fact that they were really slow after the great financial crisis to rebuild given the pain that they had endured and that’s understandable.


TONY ROTH: But now with the supply chain problems that have occurred, I would’ve thought that they would be at this stage, the last couple of years and going forward, pretty sluggish as well in terms of bringing new inventory online. Is that what you’re seeing? Or, ironically, given the deceleration in the economy and the demand softness for housing are they actually increasing their activity? What, what’s going on there?

ORPHE DIVOUNGUY: Builders are basically telling you where they think demand is going to be tomorrow, right, next year. And so, they’re not going to build. We, we’re seeing building construction starts, housing starts fall back, building permits fall back, right? They’re down compared to last year.

Builders are pulling back because they understand that with affordability falling so far and housing demand falling, you know, demand not, might not be there in 2023. They’re not willing to take that chance, right? They’re not willing to take the risk. And so, they’re pulling back big-time.

What’s interesting though is that we’re seeing some building in the multifamily sector, the increase in multifamily units coming on the market, which might be a good sign for renters in the years to come.

TONY ROTH: Well, and that’s a really important point, because there’s a strong correlation between the rent market and the home market and sometimes one leads the other. But in this cycle, what we’re seeing is, you know, both have really accelerated or elevated from a price point. Rent costs are just skyrocketed. And while we’re seeing home prices come down, we’re not seeing rents come down as I understand it. And the rental market is much smaller than the home market overall. I think that there’s a three or four, three-to-one or four-to-one ratio in terms of the number of people in the country that live in a owned home versus a rental.

But rental prices are still really important in the overall inflation picture. So, where do you see home prices going, Orphe, in the next six to 12 months and where do you see rental prices going?

ORPHE DIVOUNGUY: Yes. I think it’s more likely that rents will continue to increase in the near future and that’s for a number of factors where, you know, if you start with a massive housing unit deficit and even though builders started picking up their building activity, the fact that affordability has fallen down and that demand has pulled back, builders have decided to pull back. And so, it means affordability challenges are here to stay.

Now on the, in the rental market there are a couple factors. First, rent growth peaked in February. So, the good news is rent growth is now slowing, for a combination of factors. One, I think incomes with inflation being so high renters are now starting to push back on landlords and saying, look, I can’t afford this, right? And so, you have some demand coming down.

But also, you have some supply coming up, right? You have an increase in supply in the rental markets because, of course, it was a great time to be a landlord, with rents increasing so much. And so, the combination of these two factors is going to pull down the rent growth. And so, we’re going to see rent continue to increase but at a much slower pace than they have during the past year or so.

Historically, rents follow house prices.

TONY ROTH: The owner market bleeds the rental market. And so, you are seeing home prices for single-family homes, you’re seeing those come down, condos, etcetera. So, where do you see home prices, again, in, by the end of next year? How far down do we have to fall, do you think, in this market?

ORPHE DIVOUNGUY: It’s very hard to predict where they’re going. But it’s going to take a massive, massive shock to bring down home values to their pre-pandemic level, right? So, you have to understand that a typical home saw a 40% appreciation in the last couple years during the pandemic. Homeowners have better credit, lower debt servicing as a share of income. A strong labor market. Today we saw an increase in job openings by 437,000…


ORPHE DIVOUNGUY: ... right, which is –

TONY ROTH: Yeah. That was a little bit depressing in terms of –


TONY ROTH: – the inflation story, right? So –

ORPHE DIVOUNGUY: That's right.

TONY ROTH: Just to everyone understands what Orphe’s talking about, we had a number that came out today. Today’s November 1st, the recording date, and that number reflected an increase in job openings of almost a half a million, which is not good for inflation, because it means that in the dynamic, supply/demand dynamic for labor, there’s relatively more demand, more job openings and that means that wages are going to continue to have significant pressure and that’s not good for inflation. But that’s a separate podcast

But it’s related because it means that, you know, what’s interesting is that real wages have been dropping. So, even though wages are going up because inflation is so high, after inflation wages, real wages, they’re dropping. And that’s the reason, as you explained to us, that there’s some downward pressure on rents, not enough to push them down but enough to slow the speed of increases.

ORPHE DIVOUNGUY: That's right. Renters are saying, look, I'm not going to move and face the much, much higher rent. I’ll just stay put where my rent increase will be much lower. That’s what we’re seeing in the rental market.

But going back to what, my story, homeowners are comfortable. They don’t have, right, they’re low rates. It’s going to be very hard to lose your job right now, right, for most Americans and not find another one. It would take a massive shock to bring home prices down rapidly.

I mean they’re, you know, they’re still, year-over-year prices are still up, are still in positive territory. There’s too much upward pressure. With new listings falling back, there’s still too much upward pressure on prices to prevent the kind of crisis that we saw before the global financial crisis.

TONY ROTH: Which is troubling news as it relates to the economy, because the kind of shock you’re talking about is probably not even a mild recession but more of a severe recession where you lose three to five million jobs in the economy and all of a sudden you start to see more of a collapse in demand, if you will, to bring prices down. And that’s not going to happen in our view.

ORPHE DIVOUNGUY: Today’s environment is a little bit different, right? We talk about demand coming down. Before the global financial crisis we had a bunch of distressed sellers coming on the market…


ORPHE DIVOUNGUY: …and that’s what drove the price slide, right?

Today, we’re—we don’t have that. I think I saw a stat. Real, 49% of realtors were dealing with a distressed seller back in 2007, 2006–2007; whereas, today the number’s only 1%, right?

TONY ROTH: Interesting.

ORPHE DIVOUNGUY: So, sellers are comfortable and until we see a massive surge of inventory across the country it’s going to be hard to see the price slide that, one that’s similar to the one that we saw before the global financial crisis.

TONY ROTH: And I want to talk about the macro a lot more and how the housing market feeds through into the inflation story. But before we get into that, tell us real quickly.

A lot of our listeners do have second homes or are interested in second homes on the beach and so on and so forth. Is that market pretty much parallel to homes for wealthy folks across the country or is there something different going on there as well?

ORPHE DIVOUNGUY: I love that question. I think you’re seeing really expensive markets, seeing massive surges in inventory, and prices start to slow down. But the second home market, I think there’s less appetite for a second home right now across the board.

By the way, wealthy, the wealthy are more responsive to prices, more responsive to changes in interest rates. And so, they want a more liquid housing market. They want to be able to buy and sell more rapidly. They’re going to put their assets in a safer place or in a place where they think, okay, well, I'm going to the second home market is not very attractive right now. But if you’re in the market for a second home, you’re probably going to see some nice discounts because it’s, you know, it’s getting very, very, very expensive to keep a second home.

TONY ROTH: So that’s an area where you are seeing some price movement, more so than in primary home residences.

ORPHE DIVOUNGUY: Absolutely. By the way, another report we put out recently was, you know, a million dollars doesn’t get you very much anymore, right? Even in the very high-end markets, houses are getting smaller, right? So, you put a lot of money into a home, but you’re not getting the type of space that you used to.

And we’re seeing these shifts, and competition is very strong at the bottom relative to the top. Even though demand has come down at every price tier, competition remains stronger at the bottom relative to the top because people are just shifting down.


ORPHE DIVOUNGUY: …especially the ones at the top. They’re very responsive. So, they’re, okay, well let’s move down to something that makes more sense in the current environment.

TONY ROTH: So, why is it that as a technical matter, and I'm the one at a bank so it’s a question that I could answer too but I'm going to ask you the question. Why do you see as rates go up, you see the spread between the benchmark rate and actual 30-year mortgages increases faster? Can you talk to us about why that is?

ORPHE DIVOUNGUY: You're the one at the bank but I have some theories about that. You basically have lenders pulling back I think on in terms of, you know, buying up mortgage-backed securities, even though delinquency rates are still very low. And by the way, if the risk-free rate goes up, right, if less risky assets become more attractive, you have to get compensated for going out and taking on more risk.

And so, with that in mind, mortgages are going to have to take higher and higher in order to attract lenders into that space. So that, that’s what I—one of the reason why I think this is, this could be happening. But also, the idea that maybe in a year or two people might be refinancing very rapidly if rates fall again could be on the market’s mind right now.

TONY ROTH: Yeah. I mean what we see is that the market for mortgage-backed securities is not nearly as strong as it has been. It’s not shut down, but it’s, of course, I mean that’s a market—

ORPHE DIVOUNGUY: That's right.

TONY ROTH: —that’s pretty much always open. But it’s not as strong as it has been as the purchasers of those securities are worried about a cycle that involves a recession and higher default rates on those kinds of securities. And that is impacting, I think, the enthusiasm for banks to lend into the market. And so, they’re looking for higher returns as they expect to see the economy slow.

ORPHE DIVOUNGUY: That's right. You have to get compensated sufficiently to take on that. Why would you take on that risk when, the 10-year is paying what it’s paying now and there's no real incentive.

And, of course, it makes me scratch my head a little bit because, look, delinquency rates are very low. They’re lower than they were before the pandemic.

And consumer credit’s really good. You wonder why lenders are pulling back so much. But, yeah. That’s the story.

TONY ROTH: So, even if we do have a mild recession next year, which in our view is 50/50 at this point, you still don’t expect foreclosures to move materially higher than they are now, very, very low rates.

ORPHE DIVOUNGUY: Look. If you can afford your mortgage payment, which most Americans can because they were locked into these really, really low rates, if you can still afford to pay the monthly mortgage, you have no incentive to put your house up for sale. And so, I don’t think we’re going to see the kind of distressed sales that we saw before the global financial crisis as a result of a mild recession. You would have to have big, big income shock to get people to basically get rid of that sweet deal, right, the golden handcuffs that are those 2.5% mortgage rates.

TONY ROTH: Exactly. So, one of the trends that typified the pandemic were people getting out of urban environments due to the, you know, concentration of people, the density. They wanted to move away from density. It felt safer. Some of that’s been reversed.

I was in New York City over the weekend and, boy, was it hopping. But what do you see from a housing market standpoint? Is the suburban housing market still benefiting from that pandemic tailwind, or has it totally reversed itself?

ORPHE DIVOUNGUY: We had a nice, interesting piece of research that actually showed it wasn’t necessarily just suburban. It was basically people wanted more space, more amenities for less, right, a bigger bang for their buck. So, they moved to the suburbs. They moved to other markets where they could get more space, right, for less.

TONY ROTH: That makes sense.

ORPHE DIVOUNGUY: And so that’s, right, and so that’s really what happened.

TONY ROTH: Needed more space away from your partner or your spouse, right? You had to get distance, right, and you had one person in the east wing and one person in the west wing.

ORPHE DIVOUNGUY: I used the pandemic to get a gym, to put a gym in my house, right? And so that, you know, I needed that space. We were stuck at home, right? And so, you needed a home office, you needed a gym potentially.

So, that’s really what happened during the pandemic. So, I don’t think there’s going to be some sort of reversal, a trend reversal here or anything like that. You have work from home that’s here to stay for the most part.

I think young people will always be close—want to be closer to the cities. That's just how it works. But I don’t think we’re going to see a big shift that happening anytime soon.

TONY ROTH: So, Orphe, because you're an economist let me just digress with you for a moment and ask about work from home. Do you work from home?

ORPHE DIVOUNGUY: I work from home most of the time. I'm in the office a couple days a week out of choice.

TONY ROTH: Yeah. I mean I go in every day when I'm not traveling. What’s really interesting is that there’s a lot of data coming out now that shows that the productivity of the economy is in freefall and there’s a lot of thesis and speculation—


TONY ROTH: —over why that is.

But one of them is that the productivity of work from home is is taking a real hit on the economy. And on any individual person, no one’s ever going to tell you or even necessarily perceive if they believe it.


TONY ROTH: They’re not going to tell you if they believe it and they’re probably not even going to perceive that they’re less productive.

ORPHE DIVOUNGUY: That's right.

TONY ROTH: So, it’s hard to get out of our own way on this question. But do you think that the work from home is a contributor potentially to this sort of collapse in productivity?

ORPHE DIVOUNGUY: I don’t think so. I mean, look, to be fair, you look at American Time Use Survey data and you see that people were working more during the pandemic but not working necessarily on their job.

That’s what you end up having and you have people working more, not necessarily working more on the job, working more on other things as well, right, taking care of loved ones and family members that, and children. But, no. I don’t think the productivity slowdown is necessarily related to work from home.

This productivity growth slowdown has been going on for almost 20 years, a little over 20 years I want to say.

Since about 2000, we started seeing this massive decline in productivity growth. Part of it is labor productivity. And I, again, I think that, you know, our education system has a lot to do with it. And so, I think, in fact I think work from home might actually be a good thing. I know at Zillow we have people working different hours. You have people who are, who work better in the nights, at night and people who work better in the morning.

And so, you’re getting better, more productive workers when you allow them to pick the times where they feel they are the most productive rather than, you know, the traditional 9:00 to 5:00. Now, of course, there’s some downsides and part of the downside is, if you have fewer interactions with more senior, more experienced colleagues, you may not, pick up the type of capital on the job, right, human capital on the job that you would’ve picked up if you had been in an office interacting with more senior colleagues who are more experienced.

TONY ROTH: Well, yeah. And we’ll take this up on another conversation. My experience is a little different because we are a business that requires deep collaboration in order to understand—

ORPHE DIVOUNGUY: That's right.

TONY ROTH: —and interpret the world. And by not being together, we just don’t get that kind of interaction and interpersonal engagement, which I think is a foundation for the kind of professional existence that we have as investors. So, it’s good. But I do think it’s going to be one of the big questions that corporate America is going to be struggling with here for the next several years at least. It really will be.

Okay. So, one of the things that we struggle with, talking about struggling, is understanding where the economy’s going from an inflation standpoint. Well, there’s two areas of the data that are really persistent, one more concerning than the other. One is wage growth and the fact that wages continue to upward, an upward movement. Even though real wages are actually declining, nominal wages just keep on growing and that’s very inflationary. Flows through to services and services are the most inflationary part of the economy right now.

ORPHE DIVOUNGUY: That’s right.

TONY ROTH: And that’s all wage based. The other is housing. And it’s interesting, because the inflation reports come out, Orphe, and then when each inflation report hits there’s a lot of handwringing around, well, the housing market is actually much weaker, but it takes a long time for the numbers to flow through because—

ORPHE DIVOUNGUY: That's right.

TONY ROTH: —one person will sell their home and then they’ll have to go into contract. Then they have to actually realize the sale in 90 days. And then, even after the sale is realized, it takes a while to get filed and then to show up in the data. Could be a five- or six-month process.

But what you're telling us is actually something different as I'm understanding it. It’s not that, primarily, that there’s this big delay. It’s just that we’re not even seeing the real weakness in the housing market, and we shouldn’t even expect to see the real weakness in the housing market. So, from a inflationary standpoint, where the data’s going, that’s not going to become sort of a turning point or a bright spot as we get into 2023, because we’re just not seeing a meaningful change in housing dynamics.

ORPHE DIVOUNGUY: No. I mean you have to understand the Fed is looking at the Consumer Price Index, right? The way shelter’s calculated in the Consumer Price Index really matters. So, they impute rents for existing homeowners.

So when we think of inflation, right, we think of the pace of increase in consumer prices. And so, because rent growth is slowing.

TONY ROTH: It’s disinflationary.

ORPHE DIVOUNGUY: Exactly. So, what I'm basically saying is that the Fed is looking at the wrong thing. CPI rent is still increasing rapidly but the market—market rents are increasing at a slower pace. It’s –

TONY ROTH: And what is that pace today?

ORPHE DIVOUNGUY: So, I think it was – last time I checked it was about 12%. It was like, I think it was 16% in February, something like that. And so –

TONY ROTH: And that’s the market rate or the CPI rate?

ORPHE DIVOUNGUY: That, that’s the market rate, right? And so –

TONY ROTH: Okay. And the CPI rate is even higher than that.

ORPHE DIVOUNGUY: The CPI rate is increasing faster. And so, like you have, yeah, so it was like 19% or something like that I think last reading.

TONY ROTH: When does the market rate get down to a level that’s consistent with historic trend for rate increases?

When does it become disinflationary enough that it really helps to change the inflation oil tanker in a different direction, no pun intended?

ORPHE DIVOUNGUY: I think it’s very, it’s a very difficult question to answer.

In the latest GDP report what we saw is signs of trouble, residential investment plunging over the past year, consumer, personal consumer spending slowing down, still very strong but slowing down tremendously, and then the story about net exports. Look. I think the Fed is realizing that the economy is slowing down and there’s trouble brewing ahead. But they’re not going to turn the ship around until they see it in the inflation, in the CPI numbers. And at that point, it could be too late.

TONY ROTH: It’s a one-year lag before market rents are reflected as rent equivalencies in CPI and they’re not going to change how they do that. So –

ORPHE DIVOUNGUY: That's right.

TONY ROTH: – we’re approaching the end of 2022. Rents are still increasing at a very high pace. If you go forward six months, what’s the outlook?

ORPHE DIVOUNGUY: Well, you know, we have a survey of experts that where we basically ask questions of experts. And rent growth is likely going to be—rents are continuing to increase. They’re just going to increase at a much slower pace. And so, that’s kind of our outlook going forward.

In terms of the macroeconomy, we don’t do any kind of macro forecasting for the most part. But, my take on this is that the Fed should really pay attention to market rents, because when market rents start to come down rapid or at least the growth rate of rents start to come down rapidly, that should raise a lot of questions about, for the Fed about, you know, where the economy is currently and where it’s going.

I really think that we’re going to see growth in CPI rents start to come down in mid-2023. And so, at that, and at that point, you know, hopefully we’re still on stable ground. With labor market numbers that we’re seeing right now, it seems like we’re still—there’s still upward price pressures coming and that we’re not likely to see the inflation print come down tremendously for the end of this year and the first and second quarter of 2023.

You also have to add something I’ve been tracking a lot, looking at a lot is all these climate disasters exacerbate supply chain issues. You know, you had the Mississippi River drying up was another big news item. You have Hurricane Ian, you know, the destruction of valuable, productive infrastructure and necessary housing in those spaces. You have the wildfires in the West and the droughts. All of these issues actually are fighting the Fed and –

TONY ROTH: Because they’re inflationary, because they impact –

ORPHE DIVOUNGUY: Yeah. That's right.

TONY ROTH: They increase demand, and they act as a downward pressure –

ORPHE DIVOUNGUY: Supply shocks.

TONY ROTH: – on the supply chain.

ORPHE DIVOUNGUY: That's right. Massive supply shocks. And so, the Fed has to worry about all that. I think climate risk is a, is an economic risk. And so, while the Fed is intent on bringing down demand, prices might not come down as fast or as soon as we hoped.

TONY ROTH: If we look at core CPI, I believe that shelter accounts for about a third of the total of core CPI. Is that about right?

ORPHE DIVOUNGUY: That's right.

TONY ROTH: So, without seeing a significant movement in shelter, it’s tough for CPI to come down too quickly –

ORPHE DIVOUNGUY: That's right.

TONY ROTH: Because it comprises such a big component of the core and that’s what the Fed tends to focus on.

ORPHE DIVOUNGUY: That's right. And, in fact, Mr. Powell came out and said, hey, that he wants to bring down the feverish housing market. And when he talks about pain, he’s mostly referring to the housing market, unfortunately.

But, again, the housing – we talk about housing market but there are many housing markets across the country and –

TONY ROTH: Of course.

ORPHE DIVOUNGUY: And so, some places are not, were not as bad as other places. And I think, you know, once we start to see prices come back to earth in some of the places that were overheated, you know, things are going to get back to normal.

TONY ROTH: So, unfortunately, we’re out of time. But there’s a couple of things that I think are really remarkable that I take away from the conversation, Orphe, which is, number one is that the speed with which interest rates went up has had not just sort of a chilling effect on demand, but also a chilling effect on supply –

ORPHE DIVOUNGUY: That's right.

TONY ROTH: – as people were locked in, maybe even unexpectedly. All of a sudden, they find themselves locked into their current housing situations. I think that’s really fascinating.

ORPHE DIVOUNGUY: It’s the story of the moment. You know, we’ve never seen that really in the past.

TONY ROTH: Yeah. And it essentially means that notwithstanding the record low level of affordability it doesn’t necessarily mean that we’re going to get the churn in the housing market that we would expect that would lead to lower prices, that would allow the clearing prices for homes to –

ORPHE DIVOUNGUY: That's right.

TONY ROTH: – drop, right? So that’s one critical takeaway. I think the other critical takeaway is this idea that because the Fed is looking at rents so carefully, but rents are continuing, even though they’re somewhat disinflationary now they’re still growing at a rate that’s much too high relative to—so, when I say they’re disinflationary, they’re growing at a lower rate—

ORPHE DIVOUNGUY: That's right.

TONY ROTH: – year-over-year. It brings inflation down. But they’re not dropping enough –

ORPHE DIVOUNGUY: That's right.

TONY ROTH: – for the Fed to meet its target of 2% overall, right?

ORPHE DIVOUNGUY: That's right.

TONY ROTH: We’re talking double digits.

TONY ROTH: And it’s going to be some time before that happens. And that’s the second takeaway.

So, when you put all that together, maybe this is how we’ll conclude. I’ll give you a bite at this very big apple which is, you know, as an economist, when you think about these housing dynamics, how big housing is in a, as a component of CPI, do you become nervous that the Fed is going to continue to raise and have to create a deeper recession in order to get the sort of the breakage in the housing market that will allow that inflation to come down, A, because it may be necessary to bring the inflation down and, B, because we’re just not going to see it otherwise in the CPI numbers given how strong the rent market is?

ORPHE DIVOUNGUY: Yeah. I, look, I worry about that, and I think there’s an alternative. And the alternative is for federal, state, and local governments to help the Fed bring down inflation.

We’re in a world of insufficient supply. And so, demand destruction may not be the only way to get the job done, right?

TONY ROTH: How realistic? I mean it sounds theoretically attractive. But we all know that government, whether it’s federal/local government, it moves very, very slowly in a very, very accretive way. And so, you know, the idea that they’re going to just all of a sudden across have a wave of loosening of zoning and ordinances and all that kind of stuff and all of the sudden the builders are going to respond to that, I mean it sounds nice but probably not really going to happen at the scale, right?

ORPHE DIVOUNGUY: That’s right. It’s political pressure. It’s people that are going to drive the change. Unfortunately, yeah, you’re right. It’s going to take a while. And but that’s really what we need to avoid the pain that we’re facing basically with the Fed continuing to raise rates.

This is a big issue for our economy today, but also going forward.

TONY ROTH: Okay. Well, Orphe, this has been a fascinating conversation. I know we’ve left a lot of loose ends, questions we don’t have the answers to, which is inevitable in the environment. I want to ask our listeners to go to wilmingtontrust.com. You’ll see shortly our Capital Market Forecast show up in December. We take a lot of these issues on headfirst, particularly the issues around the labor market. And we will continue to engage on questions around inflation and the housing market and how this dynamic is likely to evolve.

So, thank you all to our listeners. Special thanks to Orphe and to Zillow for having you today. And good luck out there, everybody, and we’ll talk to you soon.




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Dr. Orphe Divounguy
Senior Economist at Zillow

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