The Big Idea
On again, off again for new home inventories
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Homebuilders have been stuck for the last two years in a seemingly endless cycle of inventory management. After ramping up construction in the winter of 2023-2024 in hopes that aggressive interest rate cutting by the Fed would lead to a dramatic fall in mortgage rates and a burst of demand for homes, they have struggled for over a year to get their inventories back under control. The latest numbers suggest the recent weakness in housing starts may persist for a while.
Misplaced Optimism
Our story begins in late 2023. Many economists argued at the time that the Federal Reserve would cut rates aggressively in 2024, predicated on the prospect of a sharp deceleration in inflation. Builders interpreted this view as a sign that mortgage rates would likely drop substantially in advance of the 2024 spring selling season. Single-family housing starts jumped in late 2023, noticeably exceeding for a time 1 million seasonally adjusted annualized units. (Exhibit 1).
Exhibit 1: Single-family housing starts
Source: Census Bureau.
Of course, the Fed did not ease aggressively in early 2024—the first rate cut did not come until September—and, with mortgage rates remaining high, the 2024 spring selling season was a disappointment. The result was a backup in new home inventories, as builders’ aggressive construction campaign left them with too much product. Single-family new home inventories surged in late 2023 and early 2024, rising by close to 10% (Exhibit 2).
Exhibit 2: Single-family new home inventories
Source: Census Bureau.
First take at fixing the problem
Builders realized by the latter stages of the spring selling season last year that they had a problem. Single-family starts sank noticeably from May through August, as builders tried to slow down the construction pipeline by enough to bring inventories back into balance.
By the fall, they evidently believed that the problem was solved. Single-family starts trended higher again in the latter stages of 2024.
In real terms, the new residential construction component of GDP surged in the fourth quarter of 2023 and the first quarter of 2024, reversed those increases in the spring and summer of last year, but then bounced in the fourth quarter.
However, this optimism proved premature. Aside from a short-lived minor dip, new home inventories failed to decline.
Hope springs eternal
Evidently, in a déjà vu moment, builders were willing to bet on a robust spring selling season again this year. Single-family starts were robust again in the fall and winter. The GDP accounts recorded a solid gain in real new residential construction in the first quarter. However, new home inventories continued to surge.
The industry was evidently again pinning its hopes on a big spring selling season. We will never know what might have happened in a more normal course of events this year, but circumstances intervened to dash builders’ optimism. The imposition of tariff hikes delivered a double whammy to housing demand. First, the ensuing plunge in consumer confidence and erosion in job security worked to reduce prospective buyers’ appetite to purchase new homes. Typically, when the economy softens or is expected to soften, there is an offsetting force, as interest rates slide, improving the affordability of homes. However, this spring, the economic outlook darkened and interest rate simultaneously jumped, returning to nearly 7%.
Looking ahead
Where does that leave us as we look forward to the remainder of 2025? Another disappointing spring selling season is wrapping up, and builders appear to be quite serious about getting their inventories back into balance. New residential construction activity on a seasonally adjusted basis peaked in January and then fell noticeably in February, March, and April. As a result, we appear on course for a substantial decline in real activity in the current quarter and perhaps further weakness in the summer.
Another negative factor for the time being is one that is also relevant for many other parts of the economy at the moment. A number of important construction materials are imported and subject to hefty tariffs. The combination of higher construction costs and heightened uncertainty on whether the tariffs will be reduced seems likely to convince builders to take a cautious approach, perhaps hoping that tariffs on Canadian lumber or other imports could get reduced or removed in a few months’ time.
In any case, in the near term, new home inventories have only begun to fall back toward a more balanced level, so construction activity could remain soft for longer than last year’s brief pullback. I am optimistic that the tariff-related uncertainty will be mostly resolved before the end of the year, in which case housing demand could firm up somewhat in 2026. However, until then, it is likely that the housing sector will be a modest drag for the overall economy.
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