Economic headwinds: Housing

The economic downturn caused by the pandemic created widely different experiences across sectors, with housing emerging as a bright spot in the economy. After temporarily plummeting in 2020, demand for housing rebounded stronger than ever as a result of changing consumer preferences and historically low mortgage rates. Limited resale inventory pushed many buyers to the market for new homes; however, lack of skilled labor and supply chain constraints restricted the ability of builders to meet surging demand.

Just as supply chains are beginning to ease, builders are now facing a considerable slowdown in demand. The rapid appreciation of homes over the last two years and an even more rapid rise in mortgage rates resulting from the Federal Reserve’s efforts to control inflation through aggressive policy rate hikes, have crushed affordability for aspiring homebuyers, causing many to pull back.

By the numbers:

Housing sentiment has fallen sharply over the last few months, a direct result of prices becoming unaffordable for many. The Home Builders Market Index, as measured by the National Association of Home Builders, fell to 55 in June from 83 in January. Weaker sentiment is a direct result of declining demand caused by affordability constraints for buyers. It has caused a pullback in new home construction, particularly affecting the single-family market.

Annualized single-family permits and starts declined to 970,000 and 982,000, respectively, in June, from 1,051,000 and 1,068,000 in May, according to the U.S. Census Bureau, each falling below 1 million for the first time in two years. While builders are still working through backlogs, new permits and starts are likely to continue falling as builders work to complete homes already under construction and push completed homes and homes nearing completion in an environment of softer demand.  

The top challenge for the homebuilding industry in a slowing economy is affordability.

The cooling in demand does not mean that Americans no longer need homes; in fact, it’s quite the contrary. We estimate that the United States was short approximately 3.5 million homes at the end of last year. Meanwhile, household formations continue to grow. Rapid appreciation of home prices and even more rapidly rising mortgage rates due to the Fed’s rate hikes have pushed would-be buyers to the sidelines. The Housing Affordability Index, as measured by the National Association of Realtors, fell to 102.8 in the second quarter, from 147.7 in the same period last year, while the New Buyer Affordability Index dropped to 68, compared to 97.3. Both were record lows. A value of 100 means that a family with the median U.S. income is earning exactly enough to qualify for a mortgage on a median-priced home, assuming a 20% down payment.

While America still needs houses, the cooling demand has caused builders to slow construction, as they work to manage inventory levels in a softer demand environment.

Labor and supply chain constraints present additional challenges to the sector.

Builders have struggled with a shortage of skilled labor for years, as much of the workforce upskilled or reskilled following the layoffs from the Great Recession. The pandemic exacerbated the tight labor market and brought other challenges, including material shortages and shipping delays.

Construction activity has slowed, with permits and starts at annualized rates of 1.67 million and 1.45 million, respectively, in July, compared to 1.84 million and 1.67 million at the beginning of this year according to the U.S. Census Bureau. Builders continue to deal with labor and supply challenges, which prevent them from returning to historical build times. On the plus side, supply chain constraints appear to be easing.

Further pull-back in construction may create a more balanced labor market for builders; however, builders must be cautious to evaluate long-term conditions and continue recruiting.

The sector is mitigating these challenges in various ways.

As demand softens, builders are adapting to market conditions. They are adjusting pricing and incentives, such as rate buy downs, to continue selling their inventory and help offset affordability constraints for buyers. This should not present a problem for builders, as they have benefitted from record margins over the last couple of years.  

Builders have also had to increase compensation and benefits to attract labor. And they are adding suppliers and providing lead time to their suppliers on future needs, to help mitigate some of the supply-chain challenges and stabilize build times.

Many builders have also entered into or expanded their build-to-rent operations. Single-family build-to-rent communities provide housing options for those not ready to buy or still saving for a down payment while helping builders diversify income streams.