In the children’s game by which we have titled this post, all players but one stand at a distance from the “goal”. The solitary player stands at the goal and shouts instructions to run or stop. Home buyers have been playing this game with consistent, emphatic instructions to run toward buying a home.
The Housing Market Surely Has Reversed Course Rapidly
For most of the last several years, the solitary player declaring “go, run, go” was a hybrid being of historically low interest rates, the remote work explosion, and fear of missing out. Within several months from March to September of this year, a new player took over — a combination of rapidly rising mortgage rates and fear, uncertainty, and doubt. The two players swapped roles so quickly thanks to an aggressive Federal Reserve Bank interest rate policy and the extraordinary speed at which media, analysts, data mavens, and others aggregate, crunch, and spew data about the housing market often with hyperbolic language.
The environment for home sellers and buyers may have changed rapidly — indeed more rapidly than even in 2006 (which began a downturn that took six years to hit bottom), but the changes are almost certainly not permanent. Perhaps most fundamentally, the human need for housing will not change. The American yearning for bigger and better living spaces is not likely to disappear.
The Course Change Is Not Permanent
The demand for housing may be elastic in the short-term as young people especially consolidate their living situation with parents or roommates or smaller living spaces, but in the long-term new households will want to form and expand. Any suppression of demand in the short-term will increase the backlog of demand longer term. The most recent housing price escalation arose in large measure because production of new homes declined so sharply during the 2007 Great Recession through 2012.
While interest rates and high rents temporarily depress demand, the supply of housing is not likely to explode to bring the demand-supply forces into balance. Housing supply has been short of demand for a long time by millions of units, according to numerous reports from the housing industry, financial institutions, and the government. Builders are completing in-process homes now but starts are declining. Multi-family projects also will complete to bring hundreds of thousands of new homes to market, but even depressed demand will absorb most of that inventory, especially if home prices and rents soften.
The Housing Shortage Is Endemic
Once the in-process inventory of housing completes and is absorbed, builders will find an unfriendly lending environment for new projects. Interest rates have more than doubled since January. The economics of all housing becomes challenging when the cost of financing increases so dramatically alongside still elevated construction costs and labor and materials shortages.
Links to the press releases, analyst and industry reports, and government data mentioned in this post can be found in our weekly data summaries.
The speed of information has led to a speedy response in the housing market. Home prices surely will fall in the near-term as builders discount to move inventory, but that inventory will not be quickly replaced. Supply will rise for a time and then decline. Builders and bankers remember well the last downturn and most will not foolishly wander through the same thicket again.
Commercial lenders will tighten the reins on builder credit lines. Builders are canceling and will continue to cancel lot purchase agreements, leaving land owners with deposit windfalls but no means to develop lots for the future. Developers will not develop if builders will not buy developed property.
These dynamics are logical in our capitalistic economy.
History Likely Will Be Resurrected
Developers and builders who rode the six-year coaster from 2006 to 2012 know what will happen in the medium term. After prices fall and supply is absorbed by households at a discount to today’s prices, housing inventory will fall below demand. While the backlog of new household formation will build pressure behind the cork of high interest rates, as the Federal Reserve eases its policy tightening, homebuyers will emerge from their hibernation.
The first buyers to emerge may find a friendly market with sellers eager to accept offers. Builders will be happy to accept pre-sales contracts to deliver new homes at much reduced risk, if the Builders can find lots on which to construct homes. And, there is the rub.
The rapidly decelerating housing market today has slowed and will continue to press the brake pedal on the earliest stages of housing production. Land development (already difficult to finance in the aftermath of 2006) will diminish. Land owners will stop seeking entitlement for new projects. The foundation of new housing will erode.
When those early risers from homebuying hibernation pioneer the next recovery, they will have fewer location choices. Builders will have fewer communities to offer. These early-in-the-recovery purchases will be the flint that re-ignites land sales, entitlement, and development, but that process is lengthy. A home can be constructed in several months, but lot development takes years to occur and is a much more substantial investment, harder to finance, and more risky in the face of legal hurdles, at least.
The shortage of lots will drive up home prices as the imbalance of supply and demand exacerbates once again. Any affordability relief that may occur in the next year or two will disappear rapidly, as it did once home buying resurged after the initial impact of the Covid-19 pandemic eased. History will repeat itself because nothing really will have changed in the U.S. housing market.
We are not fans of forecasting, but we are confident that the ongoing shortage of housing and the powerful desire for home ownership will bring the U.S. housing market full circle and very possibly with more steeply rising prices and housing scarcity. The smart money is searching for the tailwinds of the next housing recovery, not fighting the headwinds of today’s malaise.
