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A Market-Driven Measure of Owners' Equivalent Rent


The government estimates OER, but you can do it yourself with REIT differentials. However, there are cautions when using either indicator.

New housing construction has been shifting gradually toward more multi-family units and away from the classic single-family detached home for some time. (See Housing Market: The Shift to Tenancy Continues.) Not that the US is getting carried away with this trend -- the percentage of multi-family starts was much higher during the early 1960s and again during the early 1970s when both demographics and economics were considerably different.

In addition to housing construction numbers, I have been using an indicator based on the return differential between apartment REITs and all REITs to assess where owners' equivalent rent, or OER, is headed. If you want to get the moon-howlers going, OER is a good place to start; only the monthly employment report's birth/death estimate of new businesses seems to get a similar reaction. The reason is simple: OER is the implied price at which a home could be rented each month.

As the Bureau of Labor Statistics, or BLS, notes:
Clearly, the rental value of owned homes is not an easily determined dollar amount, and Housing survey analysts must spend considerable time and effort in estimating this value.

Even the BLS is telling you to take the numbers with a grain of salt.

The Apartment REIT Indicator
As a companion to the BLS numbers, I track OER through REITs for a market-based perspective.

The return differential between all REITs and apartment REITs has been expanding very rapidly since early February; apartment REITs have returned 4.78% versus 2.16% for all REITs. By itself, this is signaling an increase in OER going forward for at least three months. As OER constitutes 25.593% of the consumer price index, this indication by itself should set off alarm bells for those fearful of rising inflation readings.

However, before you go ride off to spread the alarm to every village and farm or whatever it is you do in these situations, take a look at the composition of those gaudy apartment REIT returns. The excess returns derive from just three issues: Essex Property Trust (ESS), AvalonBay Communities (AVB), and Equity Residential (EQR).

Even if you believe these stocks can keep powering ahead of other REITs, caution is advised if for no other reason than relative performance is highly sensitive to the starting date chosen. If we used year-to-date returns, apartment REITs would be lagging the entirety of REITs in return, 9.68% to 11.25%. Would that mean we could blow the all-clear siren on rising OER and by extension on consumer prices? Hardly.

I prefer to use market-derived measures wherever and whenever possible as they eliminate quibbling over calculation methodologies. However, when a market measure is so sensitive to the performance of just a few stocks and to the start-date chosen, I have to take a page from the BLS website and advise taking even the market numbers with a grain of salt.
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No positions in stocks mentioned.

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