High Cost of Housing May Spur Some Inflation in L.A.

WHILE consumer inflation turned out to be pretty benign last month, other numbers suggest that housing costs in Los Angeles are accelerating upward and may ignite inflation at the local level.

Limited supply and increasing demand have been driving up rents in L.A. County, and because hardly any apartment construction is underway, rents are expected to keep climbing at a pace of 5 percent to 7 percent per year. Meanwhile, median L.A. home prices are likely to go up as well, albeit at a slower rate than they have over the past two years - at 4-5 percent per year.

The situation has unsettling consequences for L.A.'s overall economy because accelerating housing prices eventually act as a deterrent to growth (as the Bay Area is now finding out).

Also, rising home prices could trigger wage inflation, as workers demand more pay to cover their costlier housing. And wage inflation, in turn, can trigger broader-based inflation, with all consumer prices being sent into an upward spiral.

"As housing in Los Angeles continues to become less affordable, because there is a major constraint on the supply, this will start to affect key industries, such as entertainment and new media," said G.U. Krueger, deputy chief economist with the California Association of Realtors. "And it will have an adverse effect on long-term economic growth."

Shelter (housing costs, excluding utilities and furnishings) accounts for 35 percent of the CPI for the Los Angeles metro area, which includes L.A., Orange, and Riverside counties.

That makes shelter the largest single household expenditure, and larger than in most other metropolitan areas. By comparison, housing costs are 30 percent of the CPI for all U.S. cities combined.

"This is one area in which Los Angeles deviates considerably from the rest of the country," said Tom Lieser, executive director of the UCLA Anderson Forecast. "Because incomes are lower here than in, for example, Northern California, this is a less-affordable housing market, and I expect that the critically low construction of multifamily housing will in fact start to have an impact on the (consumer-price) index."

Consumer prices in the Los Angeles area rose by 2.8 percent in September, year over year. That was pretty much in line with the national increase of 2.6 percent and in itself is no cause for surprise or worry. But the cost of shelter was up 3.5 percent in Los Angeles, compared with 2.4 percent nationwide.

Even that may seem rather modest, given that real estate research firm RealFacts reported the average L.A. apartment rent in September was 7.9 percent higher than a year earlier. In addition, the latest available data from First American Real Estate Solutions indicate that the median home sale price in L.A. County was up 5.7 percent in August.

There are several reasons why the CPI increase is considerably lower than those of other reports, said Nancy Treadwell, regional economist with the Bureau of Labor Statistics in San Francisco.

"In the first place, we use a fixed market basket to determine the CPI, and if you use a different sample, the results will turn out to be different as well."

Because RealFacts' sample is based on L.A. County apartment buildings with more than 90 units, and the Bureau of Labor Statistics looks at a broader sample of buildings in a wider area, certain discrepancies in the numbers are to be expected.

But a report on the Los Angeles apartment market by real estate investment and brokerage firm Marcus & Millichap shows a 6 percent increase in average rents in L.A. County, using a more diverse sample than that employed by RealFacts.

And there is good reason to believe that the growing demand for apartments coupled with little new construction will drive up rents further in L.A in the coming years, increasing the likelihood that the local CPI will be pushed northward.

"Only a fraction of the multifamily housing units that we need is being built," said Christopher Owen, research manager with Marcus & Millichap. "We could easily absorb 20,000 to 30,000 new units per year, but this year only about 4,000 multifamily permits have been issued so far. And what gets built are mostly condominiums and high-end apartment buildings on the Westside."

Marcus & Millichap's report projects that the population of L.A. County will grow by 170,000 households over the next five years, with one-third of the new households occupying apartments rather than single-family homes. Currently, a little over half of all households in L.A. live in an apartment.

According to Owen, the biggest rent increases have been in places like Santa Monica and West Hollywood, where demand is highest and rents have jumped by as much as 15 percent over the past year. But he sees a ripple effect to other, less-popular areas, as renters seek alternatives to the super-hot markets.

The ripple effect will be similar to the one that has gone through the housing market over the last few years.