Anyone who follows housing knows that things are pretty wild right now. The word “wild” evokes a certain measure of subjectivity—after all, some people like things wild. Some people very much do not.
But more and more folks are finding themselves wishing things would settle down. (Unless you are listing a property with plans to downsize mightily on your next home—in which case you’re a happy camper).
But for prospective buyers, flippers, and rental property investors, there’s a lot of sticker shock. And the newest knot in the mix is the sticker shock seen by homebuilders on raw materials and labor costs. There are massive bottlenecks and price increases throughout the builder supply chain, and this threatens to dampen new supply precisely when it’s needed most to meet the insatiable demand.
The demand side of the housing market is running hot—a combination of the organic growth from demographic shifts as Millennials become the largest homebuying block, and the pent-up demand left over from the tumbleweed months of the pandemic.
Everyone with their hands in the industry has their anecdotes. Bidding wars before a listing even pops up on anyone’s radar. New builds sold for $30,000, $40,000, $60,000 over a month-old spec before the foundation is even laid. Or buyers on a budget visiting 70, 80, or even 100 properties with no luck while continually pruning their wish list for size, location, and features.
Here’s the facts that frame how the market got so wild and what we can expect to see in the months ahead.
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Prices. Just. Keep. Rising.
Last week we saw the latest S&P CoreLogic Case-Shiller National Home Price Index for the March period, which printed another scorcher. The national index rose 13.2% year-over-year—the fastest growth since 2005. It was also the 10th straight month of accelerating gains, besting the 12% growth seen in February.
Results were similar across the urban sub-indexes, with the 20-city Case-Shiller composite up 13.3% and the 10-city up 12.8%.
Two quick notes about these average sales prices. First, this is on a lag. We’re already 8 weeks ahead of the data sample here. Estimates are for roughly 14% year-over-year growth in April… and the past few months have surpassed estimates. We’re probably not yet peaking in this pricing surge, but some signals suggest we’re only a month or two away from a near-term peak.
Secondly, average selling prices continue to rise even as mortgage rates creep higher. The average rate on a 30-year fixed just ticked above 3% for the first time in two months this past week. Most economists predict rates to move higher throughout the summer while remaining moderate enough to not create tremors in the housing market. The winds of inflation are out there, but not blowing anything over as of yet.
In March, there were just as many new homes that sold for more than $500,000 as properties selling for under $300,000. Just two years ago, there were 140% more homes that sold for under $300,000. That’s stark, especially as many of those homes are in ZIP codes not used to seeing such things.
Affordability is starting to slip
The math is quite clear in this regard. Skyrocketing selling prices means that unless household incomes are rising faster than home prices are and mortgage rates are flat or falling, affordability will decrease for a median buyer. And that’s just what we’re beginning to see.
Income gains have been strong nationally, about 11% year-over-year (excluding stimulus payments). Still, that’s less than the increases in average home prices. The other factor is mortgage rates, which have held steady enough in 2021 not to shift the equation. But it’s a precipitous zone we’re in if we (rightly?) assume average selling prices have not yet peaked.
The National Association of Realtors (NAR) publishes an affordability index that still shows an overall solid trend line, but the newest data suggests a downward click in affordability nationwide. Home prices are rising just too fast.
According to First American Economics, in 45 of the 50 largest markets, affordability is increasingly becoming an issue.
This dynamic will lead to more sticker shock for more buyers, and at the margin, more people backing away from making purchases right now. In the months ahead, this should give us a clear price peak and a mild retreat in average selling prices.
This assumes that mortgage rates stay an “equal factor” and don’t move sharply in either direction throughout the summer. The Federal Reserve, for its part, is committing to continue buying mortgage-backed securities (MBS) and has become a cheerleading group with only one chant: “Don’t worry, we’ll keep rates low as long as humanly possible.” They have some power to keep that promise, but financial markets will choose for them in the end.
On the big picture side of the economy, all signs point green. The Q1 GDP was 6.4%, and unemployment claims just hit a one-year “pandemic low.” All good, but also indicative of potentially higher interest rates in the months ahead.
Too few properties, too many buyers
A sad statistic: According to data from Altos Research, the inventory of single-family homes for sale actually made its highest weekly jump in more than two years last week. Why is that sad? Because it’s a drop in the bucket in terms of need.
Demographics, pent-up demand from 2020, secular shifts in remote work capabilities—all these factors create higher numbers of wanting homebuyers. But increasingly, individuals have to compete with investors big and small, from the entrepreneurial all the way up to giant pools of institutional capital, foreign and domestic.
Homebuyers are squeezed
In Thursday’s NAR Pending Home Sales report, NAR’s chief economist Lawrence Yun noted, “Contract signings are approaching pre-pandemic levels after the big surge due to the lack of sufficient supply of affordable homes. The upper-end market is still moving sharply as inventory is more plentiful there.”
This speaks again to the affordability issues growing in the lower and middle price zones of the market. And it’s already showing up in the data. Existing home sales took an unexpected 2.7% dip in April, and pending home sales fell 4.4% versus expectations of an increase. Boots on the ground suggest that current trends are accelerating.
Data from Zonda research indicates prospective buyers at the margin are experiencing significant hesitancy—and sticker shock. In May, hesitancy from buyers spiked to 40%.
Construction is lumbering
Yeah, it’s a bad pun. Sometimes we can’t resist. But new home construction is stalling thanks to rampant supply constraints brought on by raw material costs that are going supernova. Copper is up 34% year-to-date. And lumber? Um, well…
One Denver builder says they are “limiting sales at all communities and gapping out on lots. Material availability is becoming more concerning.”
And a Charlotte builder adds, “No pre-sales as of now. Starting specs and will price at drywall. Sales are still strong, but we are starting to see a little bit of a slowdown as we have pushed pricing considerably.”
A Raleigh-Durham builder is “starting to see some reluctance and concern around home prices balancing, to some extent, the buying frenzy that we have seen over the last few months.” The builder continues to raise prices: “We get material and labor cost increase notices every day!”
Homebuilders face a big problem—trying to guesstimate how much they can actually sell a new home given higher and higher costs are compressed margins. The price increases they’re pushing through are sticking—for now. But it’s a day-to-day battle when window frames, doors, wiring, and foundation materials are rising 10% to 15% per month.
The next couple of months will be critical tone-setters. Will supply and demand rebalance? Or will continued higher average home prices start shoving people clear out of the market? The latter will create more messiness than most real estate investors are prepared for—but could be great for rental property owners, as more folks will shrug and continue to rent.
The ultimate X factor is the mortgage rate trend—and specifically the rate of inflation that invariably moves mortgage rates. The Fed can cheerlead all it wants, but if inflation continues to spike, the market will move regardless of what the Fed wants or says. Things like lumber prices, agricultural commodities, metals, fuel—they’re already rising much faster than the “stated rate of inflation.”
For now, it’s steady as she goes in mortgage rate land, but wild times may be around the corner.