The US housing market is now completely broken

Oct 20, 2023


FOR the first time since the Federal Reserve started raising interest rates, every part of the housing market is now poised to worsen.

The resale market has been slumping since early 2022 as potential sellers sit on their homes rather than give up low mortgage rates. New houses had offered buyers some respite. No more. The recent surge in mortgage rates to as high as 8 per cent has been too much for homebuilders. They will likely reduce construction in the months ahead as profit margins fall. Apartment construction has also rolled over in recent months as developers are hit with a combination of sluggish rent growth and high financing costs.

The frustration among potential homebuyers is well understood. What of the macroeconomic implications? Given the importance of housing to overall activity, subdued residential construction should limit how fast the economy can grow, though not enough to trigger a recession over the next couple of quarters. To the extent that the brutal sell-off in Treasuries has been in response to hotter-than-hoped-for economic data, a paralysed housing sector will offer some respite.

The housing market is responding very differently to the latest run-up in mortgage rates compared with 2022. Then, the strike by home sellers boosted demand for newly constructed houses. Homebuilders became the one bright spot in the market. A lack of inventory kept prices high, allowing companies to use their healthy profit margins to buy down mortgage rates and improve affordability for buyers. That no longer appears to be the case. Buying down home-loan rates to 5.5 per cent – the magic level for would-be buyers – is a lot easier around 7 per cent than around 8 per cent. Confidence among builders is going the way of their stock prices and profit margins. The National Association of Home Builders/Wells Fargo gauge of sentiment dropped to its lowest level since January this month. We should expect builders to cut back on their production plans going forward.

Multi-family housing starts also enjoyed relative stability earlier in the year, and units under construction were growing as supply chain delays kept projects from completion. The past two months have seen a notable drop-off – starts in September were down 31.5 per cent year over year and, importantly, units under construction have fallen for two consecutive months, signalling we’re likely past the peak for this cycle. With fewer units being started and a shrinking number under construction, the rental market should be a drag on economic growth well into 2024.

From an investor’s perspective, this all matters at a time when robust consumption and lofty expectations for third-quarter real gross domestic product growth have driven a stunning sell-off in Treasuries. JPMorgan Chase. estimates that the economy expanded at a pace north of 4 per cent last quarter. Part of that boost comes from housing, which should add to GDP growth for the first time since early 2021 thanks to this summer’s pickup in single-family housing starts. That’s unlikely to continue in the current quarter and into 2024 unless interest rates come off.

A renewed slump in housing activity – both construction and contract closings – should weigh on consumption, which is already threatened by a host of other factors from the resumption of student loan payments to strikes by United Auto Workers and the union representing actors and television and radio artists.

This confluence may finally offer investors some respite from the run of hot economic data that’s weighed on both stocks and bonds by fuelling prospects for further monetary policy tightening. Should that turn out not to be the case, it would suggest that the labour market and consumers have even more momentum than appreciated – an uncomfortable scenario when the highest borrowing costs since the mid-2000s have already broken one market.