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What if the rental market was the first to break?

There has been an assumption that before inflation can be brought under control and property prices decline, unemployment must rise significantly. What if it was the other way around?

The Federal Reserve has forecast the unemployment rate to hit 4.4% in 2023, and others have forecasts even higher. The idea is that a strong labor market has driven up inflation and worker incomes, leading to higher housing costs in a world that hasn’t provided enough housing. High rent growth means headline inflation will remain too high.

Adding 300,000 jobs per month with wages rising 5% or more per year is clearly inconsistent with the Fed’s 2% inflation target. But there is another way to contain rent inflation: fewer tenants. Soaring rents could motivate more people to find a roommate, move back in with family, or speed up cohabitation with a loved one.

Normally that would be a wild prediction – people chose their current living arrangements for a reason – but the pandemic has caused a historic increase in household formation and it’s possible some of that will recede as some parts of our overheated economy are cooling. In fact, there is emerging data that this has started to happen over the past two months.

RealPage Market Analytics published last week that apartment demand in the third quarter was much weaker than what we have seen in the past two years “due to what appears to be a sudden stop in household formation” . The apartment listing’s monthly report for rents in September showed a 0.2% decline. Historically, rents drop a bit in September, so it’s not a huge seasonal surprise, but this is the first time we’ve seen monthly rents track what we saw in 2017-19 before the pandemic started. .

One of the many remarkable things that has happened in this first pandemic year is that we have seen a boom in both home buying and renting. It was an explosion in household formation – four million households were added between the second quarter of 2019 and the second quarter of 2020, compared to a rate of more than one million per year before the pandemic. Some people have decided to leave town to buy a house in search of more space. Others living with family or roommates have taken advantage of the temporary drop in cheap rents to secure their own homes or acquire additional space to use as a home office as remote working gains prominence.

Although some of this excess household formation has reversed, we still had two million more households at the end of the second quarter of this year than we would have had based on the pre-pandemic trend. When rents jumped in 2021, in much of the country, they were mostly recouping some of the declines that occurred in 2020. But as rents have continued to rise this year, we may have reached a tipping point in terms of affordability. Consider New York, where, according to Apartment List, the steep rise in rents from pre-pandemic levels only began in the past few months.

For tenants whose leases are expiring right now, the combination of budget-eating inflation, rents resetting to a stratospheric level, and recession fears could be too much, prompting them to find a roommate or get smaller, cheaper accommodation.

It would also be an interesting wrinkle for the conversation back at the office. For many employees, working remotely requires a home office, and home offices cost money. If rents have reached unaffordable levels, some of these home offices become unaffordable luxuries. So, as people trade into cheaper apartments, a cramped space can motivate them to spend their working day in the office.

More importantly, removing some of the excess remaining in household formation that occurred in 2020 would have important implications for inflation. There has been an untested assumption that a tight rental market and strong labor market will continue to drive up rents, creating a lingering inflation challenge for the Federal Reserve. But if we reach a price level in the apartment market that causes demand destruction, we could see an unexpected increase in vacancy rates and a faster-than-expected cooling of inflationary pressures.

The “break” of the US rental market before the labor market would be unexpected, but it appears to be a possibility. And if the trend continues, the US economy will wonder whether the official inflation data the Fed uses to make policy decisions will turn before the labor market.

More other writers at Bloomberg Opinion:

US job market is looser than it looks: Gary Shilling

Welcome to the Scary New Inflationary World: Trow and Ashworth

Biden fails homeowners in inflation fight: Karl W. Smith

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Conor Sen is a Bloomberg Opinion columnist. He is the founder of Peachtree Creek Investments and may have an interest in the areas he writes about.

More stories like this are available at bloomberg.com/opinion

Margarita W. Wilson

The author Margarita W. Wilson