Real Estate values and the CPI - rental equivalence explained

Rental Equivalence--Background

Until the early 1980s, the CPI used what is called the asset price method to measure the change in the costs of owner-occupied housing. The asset price method treats the purchase of an asset, such as a house, as it does the purchase of any consumer good. Because the asset price method can lead to inappropriate results for goods that are purchased largely for investment reasons, the CPI implemented the rental equivalence approach to measuring price change for owner-occupied housing. It was implemented for the CPI-U in January 1983 and for the CPI for Urban Wage Earners and Clerical Workers (CPI-W) in January 1985.

Rental equivalence. This approach measures the change in the price of the shelter services provided by owner-occupied housing. Rental equivalence measures the change in the implicit rent, which is the amount a homeowner would pay to rent, or would earn from renting, his or her home in a competitive market. 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.

When initially introduced, the rental equivalence index’s monthly movement was calculated by reweighting the rent sample to represent owner-occupied units. Starting with the CPI for January 1987, the rental equivalence index movement was based on changes in the implicit rents of a sample of owner-occupied units. As part of the 1987 revision, BLS drew a new housing sample to replace the old rent sample. The new sample had both owner- and renter-occupied housing units. To estimate the change in the implicit rents of the owners, the CPI:

* Estimated initial implicit rents by asking the CPI data collectors to work with the owners themselves to estimate the units’ potential rent.
* Measured the change in implicit rents over time by matching owner units to renter units with similar characteristics. The characteristics included location, structure type, and other general traits such as age, number of rooms, and type of air conditioning.
* Derived the change in the implicit rent for each owner unit in the sample from the change in the actual rents of its matched set of renters. Because owners pay for utilities separately, the CPI calculated the pure rent of the matched renters by removing the value of any landlord-provide utilities and furniture. The implicit rents of the owner units were moved by the changes in the pure rents of the matched renters.
* Moved the rental equivalence index by the average changes in the implicit rents of the owner units.

In 1997, BLS started the process of developing a new housing sample to replace the one that had been in use since 1987, and began using it starting with the index for January 1999. BLS dropped the owner sample and returned to the method that was used for the rental equivalence index when it was first introduced, that is, reweighting the renter sample to represent owner-occupied units.

This decision was made for several reasons:

* Moving implicit rents by matching renter and owner observations is inherently a reweighting of the rent sample.
* A large portion of the 1987 sample was devoted to owners, to support the estimation of initial implicit rent. By dropping the owner sample, the field staff would not have to initiate, price, and maintain an owner sample.
* Because owner-renter matching is not needed for rental equivalence, the calculation of the index would be greatly simplified.

you can learn more at the Bureau of Labor Statistics website