The past year has been a headache for would-be home buyers who dealt with quickly-rising prices and a shrinking number of options. That buyer squeeze now seems to be easing — and the housing headache is shifting to the rental market.

Rising vacancy rates during the pandemic led to stagnant or falling rents in many metro areas, but that's showing signs of reversing, creating problems for both renters and the Federal Reserve in the months to come.

There are three factors likely to drive rents higher over the next year, at minimum. The first is the expected normalization of the economy as people get back to their pre-pandemic routines, office buildings reopen and urban life returns. Data from Apartment List shows that rents have risen at a strong rate since March in the metros that were hardest hit by the pandemic. Apart from how you feel about rising rents, this dynamic should be welcome — normal life is better than people sheltering in place or working from home because business districts have shut down.

Second is how the recent frenzy of home-buying has changed the rent-versus-own calculation. Home prices nationally are up by about 15 per cent since early 2020 — significantly more in some metro areas like Austin, Texas — while inventories, despite rising somewhat in the past month, remain near historic lows. Some people who might have bought a home are deciding to keep renting instead to give the market time to normalize.

On a cost basis, renting has become relatively more attractive too, even with the decline in mortgage rates. If home prices have risen 15 per cent or 20 per cent in your area, an apartment with rent that's 5 per cent higher is a relatively better deal than it was 18 months ago.

The third factor is the speed of wage increases in certain lower-paid service industries as companies like Inc., Chipotle Mexican Grill Inc., and Costco Wholesale Corp. engage in an arms race to staff warehouses, restaurants and big box stores. While it won't affect luxury apartments in New York or San Francisco, the higher wages will empower landlords to raise rents, particularly in metro areas that are housing-constrained.

Because renters often sign one-year leases, cumulative rent increases will phase in over the next year as contracts expire and reset. For instance, imagine that someone in San Francisco signed a lease last September for US$2,400 a month in an apartment that went for US$3,000 a month before the pandemic. By renewal time, the rent for that apartment, which has been steadily rising by about 3 per cent a month over the course of the year, has fully recovered to US$3,000. From the tenant's perspective, that represents a 25 per cent jump all at once.

This has implications for the Federal Reserve, too. In its June meeting, the Fed expressed a greater concern about inflation than it has in some time. While some of the conditions driving inflation this year will probably subside over coming months — used car prices being among the most obvious — depressed rents that were helping keep inflation in check will now be picking up.

In the May Consumer Price Inflation report, the "rent of primary residence" component rose by 1.8 per cent year-over-year, compared with close to 4 per cent in prior years. "Owners' equivalent rent," a measure of what homeowners believe their homes would rent for and another large CPI component, rose by 2 per cent year-over-year in May compared with pre-pandemic rates of around 3.3 per cent. A normalization of the rental market would mean rates comparable to those last spring, but they might even overshoot that for a while.

As market participants cheer the evidence that industries like lumber and automobiles are moving past their bout of transitory inflation, we should turn our attention to the slow-moving ship that is the rental market. A rise in rents, which may accelerate in the months to come, could lead to a new, less-transitory kind of inflation for the Fed to deal with in 2022.