New Home Construction - 4.19.2023

by Sr. Insight Analyst Ryan Schoen

Quick Hit Summary for Loan Officers

The limited existing home inventory thanks to sellers not wanting to give up sub 3% mortgage rates in most cases has caused new homes to become just under a third of the inventory available on the market, well above its historic average of around 10% of the housing market. Going forward, it appears as though we may have already seen the floor in housing construction, but the path ahead will be heavily influenced by the Fed and its success or failure in keeping the economy out of an acute or prolonged recession.

Key Points and Stats

1. The overall housing market index rose one point in April to 45 indicating a more pessimistic view than an optimistic view but the trend is our friend (<50 = negative outlook on home sales and >50 = positive).
2. The present conditions index component rose to 51 - the first time since September 2022 above 50.
3. The future sales index component rose to 50 - the first time since June 2022 at or above 50.
4. The traffic of the prospective buyer's index component remained unchanged indicating that affordability concerns are still holding back the housing market from a more substantial rebound.
5. Housing starts came in a little soft declining -0.84% M/M to a seasonally adjusted annual level of 1.42M units in March. The overall drop was tied to a drop in multi-family construction as single-family construction increased by 2.7% M/M, the second consecutive month of improvement.
6. Despite falling from a peak of 18.4% to 10.2%, annual growth in construction costs continues to remain the number one headwind facing home builders today.
7. New construction is not coming to the rescue at all price points or in all markets. Historically unaffordable markets have a low share of sales owed to new construction and new construction sales remain concentrated in the medium-high price tier within each metro respective market.

Housing Market Stabilization Has Arrived

This week we received two reports that hint at a housing market that appears to be stabilizing.

The first, the National Association of Home Builders (NAHB) Housing Market Index (HMI), indicated that home builders remained cautiously optimistic in April. Mortgage rates pulling back from recent highs, just north of 7% at the beginning of March to just north of 6% at the start of April, spurred increased sales activity.

The overall HMI rose one point to 45 indicating a more pessimistic view than an optimistic view, but the trend is our friend (<50 = negative outlook on home sales and >50 = positive). Further positive developments could be seen in 2 of 3 component indices, with the present conditions index rising to 51 (first time since September 2022 above 50) and the future sales component rising to 50 (first time since June 2022 at or above 50).

However, the traffic of prospective buyers remained unchanged indicating that affordability concerns are still holding back the housing market from a more substantial rebound. That said, builders did tighten their purse strings and have become less reliant on price cuts in order to lure in buyers as they continue to play around with margin to find the right balance between maximizing profitability and meeting the current market demand. Just 30% of builders reported reducing prices in April, down from 35% back in December. Additionally, the average price reduction has also fallen to 6% in April, down from 8% in December.

The HMI or builder confidence is an important indicator to follow because it translates strongly into the second report indicating stabilization, housing starts that the U.S. puts out on new residential construction.

Housing starts are where the rubber meets the road not just for the trajectory of the housing market, but for the economy as a whole since new construction has implications for consumer spending on big-ticket items like housewares, appliances, and furniture. The latest housing starts figure came in a little soft declining -0.84% month-over-month (M/M) to an annual level of 1.42M units in March, but the more important note is that we have started to see the baton being passed from homebuilders focusing on multi-family (apartments/rental construction) to single-family as we observed an M/M rise in permits and starts for single-family and a decline in multi-family (5+ units).

The pipeline of homes under construction shows that the housing sector seems poised for some long overdue newly completed inventory to hit the market, but there is a drastic imbalance between multi-family and single-family units coming online. The surge in multi-family homes under construction is coming at a time when demand is expected to wane amid a forecasted economic slowdown and apartment vacancy rates already trending higher indicating that a shortfall in single-family homes might not be enough to spark sustained demand as an alternative to homeownership.

New Home Construction is Increasingly More Important Now Than Ever

The trends above on home builder sentiment and housing development are more important now than ever since new construction currently represents a more outsized impact than it has historically on the direction of the housing market.

As for affordability, the charts below depict what a homebuyer can expect based on the national trends between the purchase of an existing home or new home. The purchase of a new home currently sits at an 18.7% premium in price (12-month average) to an existing home and a mortgage payment that’s $604 (20.7%) more per month. Potential homebuyers cannot buy what’s not for sale and what is for sale is likely to be an even more expensive option in today’s market relative to historic norms of previous market environments.

Despite falling from a peak of 18.4% to 10.2%, annual growth in construction costs continues to remain the number one headwind facing home builders today.

New Construction in Perspective

While the national trends are great, it must be noted that new construction is not coming to the rescue at all price points or in all markets. New construction remains suppressed at the lower end of the pricing spectrum of homes for sale. According to the American Enterprise Institute (AEI), new construction as a share of all home sales in the lowest price tier accounted for just 3.7% of sales in the fourth quarter of 2022 (top 100 largest metros only). Meanwhile, new construction accounts for 21.3% of the medium-high price tier. This means that the new inventory hitting the market isn’t going to help those without the financial resources to transact.?

Furthermore, additional new construction inventory isn’t likely to contribute meaningfully to reducing prices in historically unaffordable markets since it represents a small percentage of sales in those markets. The markets where new construction will play a factor in housing market conditions in the near term reside mainly in the southern parts of the country. Specifically, Texas (Austin, Dallas, Houston), Florida (Lakeland, Jacksonville), North Carolina (Raleigh) and South Carolina (Myrtle Beach, Charleston).

Going forward, it appears as though we may have already seen the floor in housing construction, but the path ahead will be heavily influenced by the Fed and its success or failure in keeping the economy out of an acute or prolonged recession.

Resources:

1. Housing Market Index?

2. New Residential Construction?

3. New vs Existing Home Sales?

4. AEI-Zillow New Construction Sales Index