The Big Idea
Is housing about to rebound?
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.
Last year brought a massive shock to US housing as 30-year mortgage rates surged from 3% to 7% and as rising home prices added to the drag on affordability. Housing contracted sharply in the second half of last year and appeared poised for a difficult 2023. But recent indicators suggest that housing may be closer to a bottom than previously imagined.
Affordability shock
The National Association of Realtors calculates an affordability index based on income, home prices and mortgage rates. When the index is at 100, a family with median income barely qualifies for a median-priced home, assuming a 20% down payment and the prevailing 30-year mortgage rate. A higher number means that the median income qualifies for a more-expensive-than-average home, and vice versa.
The combination of surging home prices during the pandemic and the jump in the prevailing mortgage rate from around 3% at the end of 2021 to a high of about 7% in late 2022 led to a sharp deterioration in affordability (Exhibit 1). By the second half of last year, the NAR index slumped to its lowest level since the mid-1980s, a time when 30-year mortgage rates were still in double-digit territory. The result was a sharp drop in home sales.
Exhibit 1: Falling affordability brings down total home sales
Note: Total home sales combines existing and new home sales.
Source: NAR, Census Bureau.
The close link between affordability and home sales suggests that the slump in new and existing home sales, from an annual pace of over 7 million units to less than 5 million, should be mostly but not entirely done.
Inventory overhang
Homebuilders had been playing catch-up from the early days of the pandemic, as demand for single-family homes jumped. When mortgage rates shot up last year and home sales cratered, builders were left with far too much inventory. It takes a while to shift gears, as a new home takes somewhere in the neighborhood of six months to build. Builders have started to make some headway in getting new home inventories under control but have a distance to go (Exhibit 2). The months’ supply of new homes is generally in a 4- to 6-month range when the market is close to balance. In April, the gauge slid to 7.6.
Exhibit 2: New home inventories look elevated
Source: Census Bureau.
Homeowners locked in
The jump in mortgage rates last year created a dynamic that appears to be speeding the inventory adjustment process. Most homeowners are currently servicing mortgages with rates in the 3% to 4% range. Thus, a move would entail trading that loan in for a new one with a 6.5% or 7% interest rate. As a result, homeowners are not moving at a typical pace. In fact, most households that do not have to move are staying put. Existing homes on the market have been running at historically low levels. In fact, the supply of existing homes on the market have not exceeded 3.5 months’ sales since the early days of the pandemic; the average, going back to 1999, is more than five months.
Freed from their chief competition, builders are benefiting. New home sales in April represented 14% of total home sales. The average over the previous 10 years was 10%. That four percentage point difference may not look like much at first glance, but it amounts to about 200,000 units over the course of a year. Relative to the year-to-date pace of new home sales of 650,000, that extra bit of the market is consequential for builders.
Builders feeling better
As a result, builders’ moods have been lifted. The National Association of Home Builders Sentiment gauge has surged since the turn of the year (Exhibit 3). After sliding to a decade-long low of 31 in December 2022, the index has risen for six straight months, reaching 55 in June (a reading over 50 indicates that more builders are positive than negative). To compare to the housing bust period, the NAHB measure bottomed in 2008 and did not get back above 50 until 2013. This optimism has also been reflected in recent earnings reports from home builders, as several public companies in the sector have reported orders that exceeded analysts’ expectations.
Exhibit 3: NAHB Homebuilders sentiment index rebounds
Source: NAHB.
With sales bottoming out, inventories beginning to normalize, and builders’ optimism gaining ground, groundbreaking activity has shown signs of leveling off. Single-family housing starts plunged through most of last year but stabilized late last year in the 800,000’s range and remained in that neighborhood until May’s outsized jump, which I am skeptical will be sustained.
This is reflected in the GDP figures. Residential construction activity fell in real terms at a 27% annualized clip in the third quarter last year and 25% in the fourth quarter. But the reading in the first quarter this year was “only” down 5.1% annualized. I have further modest declines penciled in for the next few quarters, but the housing sector could bottom out by the end of 2023, a result that I would not have predicted six months ago. In any case, after subtracting well over a full percentage point in the third and fourth quarters last year, housing only pulled down real GDP growth by 0.2 percentage points in the first quarter this year.
Home prices
With existing home inventories constrained and sales stabilizing, the market is coming into better balance. Home prices are showing signs of bouncing. The FHFA gauge fell modestly in the second half of last year but revived in early 2023, rising by 0.7% in February and 0.6% in March. Meanwhile, the S&P Case-Shiller CoreLogic 20-city index, which fell much more sharply last year and was down for eight straight months, bounced by 0.5% in March. It seems too soon to declare confidently that home prices have bottomed, but it is beginning to look like the bulk of the price adjustment could be behind us.
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