The Federal Reserve today held rates steady, despite many indicators that the economy and the job market are slowing.  This begs the question, what is pushing inflation higher if we are seeing slowdowns in the job market and higher unemployment?

Were you aware the largest component of the CPI (Consumer Price Index ) is housing?  That’s right, up to 44%!  Is housing up?  Darn right, even in the face of higher interest rates.  So why is this happening?

7112 Murietta Ave

There are two elephants in the room.  Airbnb/VRBO and Wall Street Hedge Funds.  Allow me to explain… The relatively recent advent of gig economy/short term rental market has removed literally tens of thousands of homes of all shapes and sizes from the for sale or for rent market.  It’s essentially converted homes into hotels.  This has two related effects.  First, it takes homes out of the sale and rental market, thereby tightening supply.  This, in turn, leads to higher prices as would-be home buyers/tenants find there is a shortage of available homes for sale or rent, and thus are forced to bid higher/pay more.  What happens when prices go up?  Rents follow.  What happens when rents go up, prices follow (Find out what your home is worth here).  It’s a predictable, if not vicious circle of housing inflation.   A self-creating upward price spiral. 

The second elephant is Wall Street hedge funds.  #InvitationHomes, #Blackstone, #AmericanHomesforRent, #ColonyCapital or #DigitalBridge are all hedge funds that recognized around 2012 that there was money to be made in single-family home ownership.  With home values in a freefall and distressed homeowners and foreclosures plentiful, these hedge funds gobbled up homes like I eat Raisinets in a Mission Impossible movie.  How many homes you ask?   Try hundreds of thousands.  And not only did these guys buy tons of homes and bad paper from the banks, but they also found that many of the locations of distress were clustered; meaning that in some markets where incomes were lower and subprime loans more commonplace, hedge funds were able to buy a disproportionate number of properties.  Now, Blackstone for example will state that they are a small player when considering the total number of single-family homes nationwide.  What they don’t tell you is that in some markets like say, poorer areas of Oakland, Ca, hedge funds own as many as 10% of the properties! 

So ask yourself this: what might the impact of such a concentration of corporately owned homes mean to home prices and furthermore, rental prices?  If you said they would drive prices up, you would be correct.  If you also said that much control in so few hands could drive up rents, you’d be right again.

So, what does all this have to do with inflation?  Since these two elephants are putting undue pressure on both prices and rents, and housing represents up to 45% of the CPI, the read that the Fed is getting is warped.  This in turn means that the Fed will keep rates higher for longer.  Higher rates mean higher borrowing costs (higher costs=inflation) not just for consumers but more importantly for developers.  If you doubt this look no further than #BarrySternlicht of #StarwoodCapital who controls over 7,000 single-family homes, and a total of 290,000 residential units.  Mr. Sternlicht says (and I’m paraphrasing) that we as a nation have a housing shortage and that higher rates mean less construction since developers are the first leg on the borrowing ladder.

Where that leaves us is this: We have unsustainable housing and rent inflation due to new entity-created supply absorption and a Fed holding the line on rates to the detriment of the new shelter creation (Contact Tim here).  All this in turn causes prices and rents to go up.  How problematic is this?  Think Nero playing violin while Rome burns.  Should Congress step in?  Maybe.  Should the Fed pivot and pivot quickly, yes.  If decisive action isn’t taken to limit short-term rentals and the number of homes hedge funds can own, I fear something is going to break and that break may well be why Americans are not feeling great about the current state of the economy.