The U.S. residential housing market is starting to show signs of weakness. In some cases, the onset has been sudden. This paper will explain more about that, the market dynamics prior to COVID-19, growth in housing demand post-pandemic and recent trends that could give insights into the market’s performance over the near-term.
Part 1: The Housing Market Before COVID-19
In the two years following the 2008 Global Financial Crisis (GFC), the housing market experienced a contraction.
In 2005, prior to the housing slowdown and subsequent GFC, the annualized number of new homes sold in the U.S. briefly broke above 1 million units per month, with an average home price of around $310,000, according to data from the U.S. Census Bureau.
Strong demand led to over 2 million units of new builds and tapered down to below 1.5 million units by the end of the year. And based on the National Association of Realtors (NAR), around 6.5 million existing home units were sold throughout the year.
As the market cooled, and in the years after the GFC, the unit volume and sales prices fell. In 2009, the annualized run rate of new home sales dipped to an average of 374,000 units with a price point of $268,000. Housing starts averaged 554,000 units per month across a year, a significant decline from the 2 million units seen just three years earlier. Thus, construction activity clearly slowed. And existing home sales dipped below 4 million units on an annualized basis but went on to recover to 4.4 million units by the end of 2009.
In 2010, the annualized new home sales dipped further to 326,000 units, while the average price improved slightly to $291,700. Housing starts improved slightly to 539,000 units on an annualized basis and existing homes sales were 4.3 million units, slightly below the same figure a year before.
But by 2012, there were clear signs that the market was starting to strengthen, which carried forward for the next seven years. This was a gradual improvement in both volumes and price points.
The average annualized rate of growth between 2012 and the end of 2019 was 3.6% with the average new home price of $377,000. Granted, within that time, there was some volatility. For example, in December 2014, the average price paid for a new home rose 16.2% from December 2013, compared to December 2019 when the figure was 1.0% less than December 2018. However, the broader trend was evident.
A Stronger Market Makes It Harder To Afford a Home
Meanwhile, housing affordability deteriorated slightly between 2012 and 2019, but was still far better than before the GFC. According to the NAR, in 2007 the average American spent 23% of their monthly income on mortgage servicing, while the housing affordability index was 100 – indicating a high degree of unaffordability across the sector. By 2013, mortgage servicing declined to less than 12% of income and the affordability index rose to a multi-year high of 213. By 2019, some increase in home prices resulted in mortgages equaling 18% of income and the index moderating to around 140.
And finally, the sales to list price for homes increased incrementally from 97% to 98% between 2012 to 2019, while the average days on the market fell from 70 to 44.
In other words, in the decade following the GFC and just before the onset of COVID-19, the housing market gradually strengthened in a relatively non-volatile manner. New home prices and the number of transacted units steadily increased, while affordability metrics were generally sound. And although mortgage rates did rise, they were still low by historical standards, reaching 4.75% in 2018, which was the highest they’d been since 2009.
Part 2: Post COVID-19 Demand Surges
Initial Worries About a Housing Market Slowdown Are Quickly Reversed With the Onset of a Pandemic
In March 2020, the first set of lockdowns from COVID-19 commenced in the U.S., which led to some initial economic reverberations and concerns that the housing market would slow. And after a brief slowdown in March 2020 (as defined by a drop in new home prices and number of units sold), the market turned around very quickly.
In April 2020, the annualized rate of home sales improved to 582,000 new units and 4.4 million existing units, which doubled to 1 million and 6.1 million respectively by August 2020. The average price for a new home increased from $360,300 to $386,300 during the same period. So, in six months, home prices rose by 7.2% while volumes surged. And housing starts increased from 938,000 units to 1.4 million units over April to August.
By the end of 2021, the U.S. was selling an average annualized rate of 839,000 new homes with an average price of $491,000. In addition, 6.1 million existing homes were being sold while 1.7 million new units were being constructed. The value of sales increased further to $569,300 by April 2022, or 58% higher than right after COVID-19 lockdowns began in April 2022.
Furthermore, the sales-to-list price breached 100% in early 2021 as homes were receiving multiple bids, and the number of days on the market for a home was only 15.
So, what explains the sudden surge in demand for housing, which led to price and supply pressures?
There were three likely drivers:
- Work from home: Many employees likely leveraged the ability to work from home to relocate to lower-cost areas of the country. For example, regional data shows that new home sales in southern states began to rise in Spring 2021. By June 2022, southern states accounted for 386,000 of the 590,000 new homes sold, a 10-percentage point increase from before the pandemic.
- Mortgages: A reduction in the Federal Funds Rates by the Federal Reserve after the onset of COVID-19 resulted in the 30-year mortgage rate reaching a low of 2.70% in late 2020. This likely incentivized potential buyers who were otherwise looking to relocate, and may have even skewed demand forward as buyers worried that rates would rise, thus advancing their purchase decisions.
- Equity: There are two aspects to the equity argument. First, a reduction in interest rates by the Fed enabled stock/equity prices and valuations to rise. From a low in March 2020, the S&P500 went on to gain 67% by the end of 2020 and 114% by the end of 2021. This likely enabled some buyers to realize their investment gains and utilize the liquidity as down payments. Second, rising home prices provided consumers with increased equity in their primary residence. It’s likely that some people used this to acquire secondary properties. As an example, cash out refinances grew from accounting for roughly 20% of all mortgage lending to 46% in early 2022. Some of this funding may have found its way back into the housing market.
Changes in Migration and Low Rates Advanced the Housing Demand
The collective effect of these trends was an increased willingness to move or buy housing with an increased means to do so as well. However, housing starts did not increase as much as necessary to absorb the demand. The annualized rate of new starts increased to 1.8 million units briefly but settled back down to below 1.5 million units. We believe construction activity lagged due to a shortage of building materials and core essentials required to build a new home.
Existing home sales also failed to increase much above the 6.1-million-unit level. Thus, capacity remained an issue, leading to multiple bids on the limited inventory as buyers sought to close their purchases before interest rates rose. This directly led to price escalations in the sector.
Part 3: Housing Set To Moderate With Falling Demand
The Market Has Suddenly Turned With Volumes and Prices Declining Suddenly, and in Some Cases, Sharply
Starting in mid-May to June 2022, the housing market appears to be weakening with an expected slowdown ahead. For example, in May, new home prices dipped 9.7% from the month before, and then fell another 11.1% in June. Furthermore, the annualized rate of new home sales has fallen from 839,000 units in December 2021 to 790,000 units in March 2022 and then to 590,000 in July. New housing starts have also declined recently, down from 1.8 million units in April to 1.4 million in July. Meanwhile, existing homes sales have been falling, down from an annualized rate of 6.5 million units in January to 5.1 million in July.
Accordingly, the volume and price points are starting to moderate. And perhaps more importantly, the pricing data has deteriorated very sharply, very quickly. In the last month alone, and in percent terms, new home sales are down 8.1%, new home sale prices are down 11.1% (as noted above), new homes for sale (i.e. inventory) are up 4.0%, existing home sales are down 5.4%, housing starts are down 9.6% and building permits have fallen 1.3%.
Higher Mortgage Rates Due to Monetary Tightening Has Likely Changed the Economics for Buyers
Higher rates are dampening demand. However, the pace of rate rises has likely deteriorated the near-term outlook at a faster than anticipated pace. The Federal Reserve turned particularly hawkish in the Spring and early Summer of 2022 when inflation readings came in. And rather than the standard 25 basis point increase, the Federal Reserve went on to raise rates by 75 basis points at the June and July meetings, taking the Fed Funds Rate to 2.50%.
Mortgages rose in kind, and the 30-year mortgage-treasury spread widened given dynamics in the interest rate market. As a result, mortgage rates rose faster than treasury yields, reaching 5.80% in June. This has since moderated slightly to 5.22%. The 30-year mortgage-treasury spread is starting to narrow again, which alongside a fall in the 30-year Treasury yield due to pending recessionary concerns could allow mortgage rates to fall slightly further.
Higher mortgage rates were hitting the market just as affordability indices were reaching historic highs. In fact, mortgage affordability was back to its pre-GFC levels as recently as June 2022, while mortgage payments as a percent of income reached above 25% recently, higher than they were before GFC. These figures are indicative of the extreme level of the prevailing housing market pricing in proportion to incomes. Accordingly, a 200 or more-basis point increase in mortgages likely forced buyers who were already potentially straining to afford a home to rethink their monthly expense calculus.
Sharply higher mortgage rates, coupled with a fall in equity markets (thus declining wealth affect), alongside worries of a potential recession likely combined to cause the recent sudden downturn in housing with builders reacting in kind. We anticipate further reductions in existing home sales, housing starts, new home sales and the price point of a new home.
Builder Sentiment Has Also Turned Negative
It’s likely for these reasons that builder sentiment has weakened too. The National Association of Home Builders (NAHB) index dipped below 50 for the first time since 2020. The headline index has been falling over the past few months, which itself points towards a weakening outlook. However, a reading below 50 indicates that builders have an overall negative view of the housing market and demand. On a regional basis, both the Midwest and West indices were 42, indicating a significantly weakened outlook, while the south remains positive at 54, down from 79 a year ago.
The Stock of Inventory Could Emerge as a Potential Threat
Another issue to monitor is the rise in projects that builders have permitted, but not begun. This figure has reached 296,000 housing units, up from 206,000 last January. To us, this figure implies that builders may have deferred launching projects that were otherwise authorized due to input material shortages. Some of the input material pressures may normalize. However, as the market slows and input material becomes more available, builders may need to offload these projects. Either way, this could add further downward pressure on the sector in the near-term.
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