Today’s edition sponsored by: JPI, Authentic, Findigs, Landing, The Kirkland Company, and Northspyre.
Higher rates are supposed to tame demand. But (so far) it’s not working for rental housing demand, only supply.
Higher interest rates are supposed to tame inflation. But could the opposite happen with shelter inflation, the largest category of the Consumer Price Index?
As the Fed debates another potential rate hike, that scenario is not as far-fetched as it may sound if you are tracking the U.S. rental housing market and understand its outsized role in the CPI.
How?
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Higher rates are supposed to bring down demand for various goods and services, yet CoStar shows 2026 is on track to be the third-best year ever for apartment absorption.
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Rental housing supply is falling much faster than demand, which puts upward pressure on rents. To be sure, a rent surge is no foregone conclusion. But in many markets (e.g. Boise, Austin, Charleston), rents are regaining steam as supply drops off. Realpage shows rent growth – while still mild – at a three-year high nationally.
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Typically when rents regain momentum, the market responds by building more supply. But today’s higher interest rates impede new construction starts, as debt costs wipe out margins needed for development to work. (Leading data providers like CoStar and Realpage show apartment starts have dropped far more than Census surveys indicate.)
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Yet this shift has drawn scant attention from the Fed (at least in their public commentaries), Fed watchers and macroeconomists.
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Ironically, it was the low rate environment of 2021-22 that helped trigger the biggest apartment supply boom in 40+ years, which in turn tamed the rapid rent inflation seen during that period.
Why is this relevant? Because rents (in various forms) comprise about 35% of the CPI and 44% of core CPI. It’s the single-largest variable of the entire index. And because CPI deeply lags real-time rents, there’s potential to miss the shifting tides until it’s too late to react.
Again, to re-state a key point: A rent surge in 2027-28 is no sure thing, and there are valid practical and technical arguments against it. But it’s a plausible scenario and a consequence of the higher-rate era that isn’t getting the attention it deserves.
Here’s what we should be talking about on rent inflation, starting with the mechanics of how it’s measured, then diving into the inflection points of 2026 and what they might mean for 2027 and beyond.
How We Measure Rent Inflation
Shelter is the largest category of the Consumer Price Index, and rent is the largest variable (by far) in shelter. Within the shelter category, we have two major components – Owners’ Equivalent Rent (OER) and Rent of Primary Residence (RPR). Many people wrongly assume that OER is based on a survey of homeowners asking about the hypothetical costs of renting their homes. This is incorrect. While that survey question does exist (as bizarre as it is), it’s used only for weighting purposes – not calculating shelter inflation itself.
Both OER and RPR rely on the same survey of about 6,000 rental units each month (though less than half that amount are successfully surveyed each month), with minor methodology tweaks between the two. It’s an antiquated methodology designed in the early 1980s, pre-dating the digital era where real-time rents are now highly transparent online. Furthermore, even though two-thirds of American households own their homes, the CPI measures their monthly housing costs not by mortgage payments or property taxes, but by rents in rental properties they don’t occupy.
Also, OER and RPR are subject to significant lags. First, the CPI accounts for the fact that rents don’t change for most renters each month because they’re on active leases, paying rates that won’t change until lease expiration. That’s sensible in some ways, but the trade-off is that CPI doesn’t capture real-time changes for renters signing a new or renewal lease each month. Second, the CPI surveys the same rental units only once every six months – creating additional lag. Obviously, the Fed is aware of the lags.
The consequence: If you exclude the lagged shelter data from the CPI, inflation would have been well within the Fed target range (and sub-2%) from May 2023 to February 2026, right before the Iran war started and inflation re-accelerated. But imagine, for a moment, the narrative shift had the CPI been hard-wired to calculate real-time rents instead of lagged rents over that 2.5+ year period.
The same lag is proving problematic today. If we used a more real-time measure for rents, the inflection point of 2026 (and potential for acceleration in 2027) would likely be more obvious to policymakers.
For balance, I should acknowledge some counterpoints to my arguments. Here are a few:
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CPI Shelter tracks not only apartments, but single-family rentals, too, especially for OER. And SFR rent growth – which outperformed apartments in recent years – has decelerated of late due, in part, to increased supply from a non-traditional source: “accidental landlords,” individuals choosing to rent out their homes instead of selling them. If that continues, you could argue it’d counteract rising apartment rent growth in the CPI’s shelter inflation calculations.
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Even if rents do re-accelerate, it’s unlikely we’ll see a repeat of 2021-22’s hyper rent inflation – and therefore the pass-through to CPI should be more muted. And this is probably the right view if you’re more worried about what CPI shows than you are about what renters actually pay. It takes significant new lease rent growth to materially jack up CPI shelter due to its lag effects and smoothing techniques, which is why it hadn’t happened in four decades prior to the post-pandemic boom.
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Starts have not totally evaporated. They’re still way above the post-GFC levels of the early 2010s, even if around half the peak levels of this decade. So the continuation of moderate supply could limit rent inflation’s ceiling.
Rate Hikes are Supposed to Tame Demand, But That’s Not Happening in Rental Housing
The Fed’s reasoning for raising rates is simple and logical. Higher rates are intended to reduce demand for various goods and services, which in turn reduces inflation. That strategy likely works well in taming demand for most categories of consumer spending and business spending. It’s likely also true of homebuying, as higher rates push would-be buyers to the sidelines.
But it’s not true – at least so far — for rental housing demand. The opposite is happening here in 2026, in part because high rates keep many renters renting longer at the same time others enter into the rental market. So even though demand drivers like job growth and household formation have slowed, apartment absorption has not, and vacancy rates are declining for the first time in 4+ years.
As a result, apartment demand exceeds most forecasts so far this year … and that means the single-largest category of CPI isn’t responsive to the Fed’s preferred medicine.
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CoStar data shows 2026 is the third-hottest year since 2000 for apartment absorption through the first nine months of the year.
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Realpage has 2026 as sixth-best over the same period.
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Apartment List shows vacancy improvement for the first time since 2021.
Back in August, CoStar’s head of multifamily research, Grant Montgomery, wrote that “the national supply-demand balance has become increasingly favorable [for apartment owners] over the past year.” In response, CoStar has bumped up its 2026 rent growth forecast twice this year, starting at basically 0% and now to 1.9%. That’s still modest, but how much further will that number climb as we move further away from peak supply?
The answer depends on whether you think early-rebound MSAs like Boise are a sign of what’s to come elsewhere. Remember all the headlines saying Boise was oversupplied and destined to see perpetual rent cuts? Well, the supply pipeline shut down, and as all those newly built units leased up, vacancy shrank and now rents are jumping again, with only the Bay Area ranking higher. Elsewhere, Austin (the posterchild for the supply boom in this cycle) is regaining momentum faster than nearly anywhere else as supply drops off. Rent cuts measured -8% year-over-year back in March. But as of September, they’re slightly positive again and could go higher.
Will we see the same pattern everywhere as supply levels dip? Maybe, maybe not. I’d guess most markets will be more muted than high-fliers like Austin and Boise, but the relationship between supply and rents is hard to ignore.
One recent study found that even a 1% increase in new supply lowers average rents by 0.19%. New supply also results in “filtering” effects, luring higher-income renters up-market and creating more availability for lesser-income renters and mid/low rent levels, putting downward pressure on rents in the process. Supply is the one proven remedy for affordability.
But Fed Policy is Cooling Housing Construction, Taming Rent Inflation’s Antidote
Fed policy does not – and CANNOT – impact shelter costs as quickly as it impacts other components of CPI, and that’s by design. There’s an intentional lag built into CPI, as noted earlier.
But Fed policy can – and DOES – impact rental housing supply. The low rates of 2021-22 played a critical role in the surge of construction starts from 2021-23 that resulted in a generational wave of completions from 2023-25, levels not seen since the 1970s. Apartment builders rely heavily on debt, and lower debt costs encourage more construction. Obviously, there were other factors, too, such as inflationary demand and rent growth of the post-pandemic era.
Fast forward to present day, and it’s the opposite. Again, yes, there are other factors. But higher rates are correlated with reduced apartment starts.
In fact, using Realpage data dating back to 2010, we find a clear relationship between Fed rate hikes and reduced apartment starts. After a Fed rate hike, apartment starts fell 11% over the next year and 17% over the next two years.
And reduced starts translates to higher rent growth. When apartment starts (on a T-12 basis) topped 450k units nationally, rent growth stalled within 2.5 years – averaging just 0.2%, according to Realpage data going back to 2010. And on the flip side (as this chart shows), the fewer the starts, the more rent growth.
(Note: The Fed rate decisions versus apartment starts analysis isn’t as clean pre-dating 2010. This is likely for several reasons, including lesser-quality data pre-2000, slower overall rate movement, wider spreads between interest rates and cap rates, etc. And rate cuts don’t always result in increased starts, particularly in a recession like 2008-2009 where demand is weak. Also, in the post-2010 era, healthy-to-strong demand has been a consistent variable.)
From public commentaries I could find, Fed leaders have generally downplayed the role of rates in stimulating housing supply and impacting shelter costs. In 2025, former Fed board chair Jerome Powell said Fed leaders “don’t really have the tools to address a secular housing shortage.” And Fed governor Michael Barr gave a speech last month that highlighted the housing supply shortage and real reasons for it, but downplayed the Fed’s role in helping mitigate it.
I have all the respect in the world for the Fed board past and present, including Powell and Barr, and those guys don’t make comments like that without good reason, so I believe their sincerity. But it’s hard to square their views with the present reality of apartment owners and builders on the ground. Nearly all of them will tell you that supply was the reason we saw rents cool from the second half of 2022 through early 2026. Not rates. It was supply. And nearly all of them will tell you that it’s gotten substantially more difficult to capitalize new construction projects since the Fed’s recent rate hike.
Michael Guckes, chief economist at construction data provider ConstructConnect, told Construction Dive that higher rates are making it harder for developers to move forward. He said: “Projects that were on the edge of meeting their profitability goals may now be falling short, such projects will not go to bid.”
For multifamily and BTR builders, the math was already getting harder due to rent cuts of 2022-25 (that resulted from the supply boom of that period), and I don’t want to downplay that. But my point is this: Even as rents start to rebound, interest rates will likely prevent starts from following suit.
How Higher Rates Hurt Apartment Builders
Today’s high rates complicate the math for developers wanting to build more apartments and BTR homes in two ways: higher costs and lower values. Builders rely heavily on construction debt, and that debt is expensive. Furthermore, property values are broadly tied to rates, which can mean (all else being equal) property values decline as rates rise. In some cases, high rates can be the difference in making a property worth less than it costs to build it. Further erosion in valuations would likely further delay the eventual recovery in construction starts.
That’s a real problem in an industry where most developers build to sell, then recycle that capital into the next project.
Unintended Consequences?
To put it simply, here’s the unintended consequence of Fed rate hikes: They’ve reduced demand for new construction of new rental housing, but they’ve not reduced demand for rental housing. That’s not a good formula for reducing rent inflation.
There’s certainly no guarantee this trend continues or that it spreads across the country from the handful of MSAs where we see it happening today. But it’s worth at least acknowledging the role Fed policy plays, and the risk of ushering in an extended low-supply era that keeps rent growth elevated for an extended period of time.
— My Latest Posts on LinkedIn —
Here are some recent posts if you missed them:
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Two charts — one from last year, one from present day — show how much the apartment market has changed in one year.
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Where does apartment absorption top supply year-to-date in 2026? (And read the text before jumping to early conclusions!)
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The reality for 2026: Apartment fundamentals are improving, but capital markets are not.
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Why is there so much hate for the Low Income Housing Tax Credit as LIHTC turns 40?
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Here’s where apartment rent momentum is shifting most.
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If you don’t believe in the laws of supply and demand, look at what’s happened in Phoenix.
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Here are the top 15 markets for apartment absorption right now.
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Austin apartment rents turned positive (barely) for the first time since early 2023.
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Continental Properties’ exec Heather Riggs has a remarkable story, which we shared on our newly launched podcast series, The Guest Card.
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Apartment demand through Q3 remained well above expectations.
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A new research paper links poverty to a lack of housing construction.
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Get familiar with the term “base effects,” as its why year-over-year rent growth is quickly improving.
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There is no such thing as Class B/C apartments.
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Apartment construction costs may be increasing again, further limiting how much could get built.
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The WSJ dives into apartment debt distress, though the challenges seem concentrated in a particular type of deal.
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Remember all those predictions since 2023 for how SFR rent growth would soar as mortgage rates jumped? Well, it hasn’t happened.
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Here’s your friendly reminder that Census data on multifamily housing starts is junk.
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How will rents be impacted now that mortgage rates reach 7%?
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Here are the higher-supplied markets already seeing a rent rebound.
— Now Spinning on The Rent Roll Podcast —
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Thank you to everyone who’s made The Rent Roll part of your weekly routine! New episodes are released every Thursday morning.
Find us on YouTube, Spotify, Apple and Amazon. Recent episodes:
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Episode 103: The Case for Multifamily & SFR with BH’s Joanna Zabriskie
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Episode 99: Rent Affordability: Myth vs. Reality with Witten Advisors’ Ryan Davis
