The Department of Housing and Urban Development (HUD) is responsible for answering just that question. To determine what level Section 8 vouchers should be set, HUD measures the rents for every county across the nation. Specifically, they measure the 40th percentile and 50th percentile (i.e., median) rents in each area. They choose to use the median so that high prices for luxury residences do not skew the measure of rent for a “typical” person in each area. How does HUD calculate these Fair Market Rents (FMR)? Today I will explain.
To start with, HUD uses household data to measures gross rents. Gross rents include both the cost for shelter (i.e., rent) and utilities. To measure these costs, HUD uses 5-year estimates from the American Community Survey (ACS). For FY2012, HUD used 2005-2009 ACS data. The advantage of using 5 years of data is that the sample size is larger, thus increasing the precision of the rent estimates. However, rent information from 2005 may be out-of-date.
To correct this problem, HUD uses a recent mover adjustment. The recent mover adjustment compares the rent estimates from the most recent 1-year ACS estimates (e.g., 2009) against the 5-year estimates (e.g., 2005-2009). If the difference between the two is statistically significant at the 90th percentile (|Z score|>1.645)1, then the rent estimates are adjusted to match the 2009 estimate. Although HUD could simply use a weighted average of the rent estimates and give more weight to more recent years, HUD does not do this, but instead uses this discrete ‘recent mover adjustment’ instead.
Using the ACS data, however, means that county rent estimates are not up-to-date through 2012. To update the rents through 2010, HUD uses an inflation factor. Specifically, they use the CPI housing index through 2010. They account for regional variation in inflation by using metro-area housing CPI estimates for large metro areas with CPI-housing data available and regional CPI-housing data where metro-level information is not available.2 D
Why do I care?
Why does the Healthcare Economist care about rental data? The reason is that the practice expense geographic practice cost index (GPCI) estimate regional variation in office rent cost for physicians using rental data from the American Community Survey. Prior to using the ACS, the practice expense GPCI relied on the HUD estimates to calculate regional variation on office rents. More detail on how the GPCIs use ACS rental data as a proxy for regional variation in physician rental costs can be found in this report.
1 HUD ensures that the recent mover estimate for each non-metropolitan portion of the state has at least 100 ACS sample observations. If any state non-metropolitan recent mover rent is based on fewer than 100 observations, the recent mover factor would be calculated based on the 1-year recent mover data and 5-year standard quality data for the entire state.
2 From the final rule: The ACS data are updated through 2009 using the one-half of the change in annual CPI measured between 2008 and 2009. This data are further updated through the end of 2010 using the annual change in CPI from 2009 to 2010. As in previous years, HUD uses Local CPI data for FMR areas with at least 75 percent of their population within Class A metropolitan areas covered by local CPI data. HUD uses Census region CPI data for FMR areas in Class B and C size metropolitan areas and non-metropolitan areas without local CPI update factors.. From 1990 to 2000, rents increased by 3 percent on average. To pro-rate 2010 rent estimates to 2012, HUD applies this 3 percent adjustment to the 2010 estimates to arrive at the final 2012 FMR estimates. It may seem odd that HUD uses old data (1990-2000) to trend rents, but the recent volatility in the housing market may imply that pre-2000 data may better reflect long-run trends in housing prices.