Home builders are holding their major convention in Las Vegas this week, and their chief economist thinks rates will “normalize” in the second half of the year.
By Kerry Smith
LAS VEGAS – The “housing recession” that began in 2022 will bleed into 2023 as elevated inflation and mortgage rates, coupled with stubbornly high building material construction costs, continue to take a toll on the housing industry. According to Robert Dietz, chief economist of the National Association of Home Builders (NAHB), that’s expected to push the overall economy into a mild recession early this year.
However, the second half of 2023 could be a turning point for housing and the economy.
“With interest rates projected to normalize in the second half of 2023 as the Federal Reserve taps the brakes in its fight against inflation, the pace of single-family construction will bottom out in the first half of 2023 and begin to improve in the latter part of the year,” said Dietz, who spoke during a housing and economic outlook press briefing at the 2023 International Builders’ Show.
“This forward momentum will lead to a calendar year gain for single-family starts in 2024.”
While home prices are declining in many U.S. markets, it hasn’t been enough so far to boost housing demand. Mortgage rates more than doubled since the beginning of 2022, and the difference between a 3% and 6% mortgage rate can add up to more than $700 per month for the cost of a typical home loan.
As a result, NAHB forecasts that home prices could fall as much as 15% in 2023 following a nearly 40% Covid-era gain. Meanwhile, just 42% of new and existing home sales are currently affordable to a typical household, which is a post-Great Recession low. Any affordability reading under 50 is considered a weak housing market, per the NAHB/Wells Fargo Housing Opportunity Index.
NAHB projects negative GDP growth for the first two quarters of 2023, which would mean that at least four of the last six quarters dating back to the second quarter of 2022 experienced negative growth.
“Our forecast is consistent with a recession call for a portion of the 2022-2023 period, as the Federal Reserve tightened monetary policy,” said Dietz. “Over recent business cycles, we’ve never had a period where home prices have declined and there has not been a recession. The rest of the economy will slow in 2023 due to tightened financial conditions.”
Fed tightening nears its end
With inflation showing signs of easing, the Fed’s actions to raise interest rates to rein in inflation should come to an end by the first quarter of this year. NAHB expects the Fed to raise short-term rates by another 25 basis points in February and a final quarter-point in March.
“Roughly 40% of the CPI is based on housing, and the Fed can do little to tame housing inflation,” said Dietz. “The only way to bring down housing inflation is to build more affordable housing.”
NAHB believes the cumulative effect of the central bank’s rate hikes will be a peak rate of just above 7%. But looking forward, NAHB expects mortgage rates to fall below 6% by 2024.
“Falling rates will set the stage for a housing rebound later in 2023, and a better affordability environment will lead to a recovery of housing demand,” said Dietz.
The pandemic severely disrupted many supply lines that builders rely on to complete homes. At its peak following the pandemic, building material prices increased at a 24% annualized rate. NAHB says that pace slowed significantly due to Fed tightening and reduction in demand; nonetheless, many builders continue to experience supply chain disruptions for electrical transformers, concrete, appliances, doors, windows and other building materials.
One bright spot is lumber. During the post-pandemic boom, a demand surged and the supply of lumber dropped. Combined with tariffs on Canadian lumber shipments into the United States, lumber prices t soared as high as $1,500 per thousand board feet.
As a result of the housing downturn, supply is no longer an issue for most builders, and the price of framing lumber has fallen below $400 per thousand board feet – back to pre-pandemic levels. However, additional lumber will be needed as the housing market rebounds later in 2023.
“We need the administration to reach a new softwood lumber agreement with Canada so that lumber supply will be sufficient for future gains in construction,” Dietz said.
On the labor front, the number of open construction positions was 388,000 in November 2022, and a focus on resolving this problem will be a key issue for the industry in the coming decade.
“We will need 740,000 construction workers annually to account for industry expansion and industry retirements,” said Dietz. “Recruiting, training and retaining skilled workers will be job No. 1.”
2022 was the first year that single-family starts declined in 11 years, falling an estimated 12% to 999,000 units. NAHB projects that single-family production will fall again in 2023 to 744,000 before rebounding to a 925,000 annual pace in 2024.
The 2022 and 2023 declines appear dramatic because production was running at a very solid level – above a 1.1 million annualized pace – through the first quarter of 2022 before beginning a steep decline after mortgage rates rose rapidly and the housing market weakened.
Multifamily: On the multifamily front, construction boomed in 2022, up an estimated 15% from the previous year to 545,000 apartment starts. Because of slowing rent growth, rising unemployment, tighter financing and a decades-high level of inventory in the pipelines, supply constraints that have caused a large backlog of projects, NAHB is projecting that multifamily starts will fall 28% this year to a 391,000 total and will stabilize in 2024 at about 374,000 starts. There are currently more than 940,000 apartments under construction, the highest total since 1973.
Remodeling: The remodeling sector remains on solid ground and will do better than the single-family and multifamily markets during the housing downturn. Residential remodeling activity is estimated to increase 7% on a nominal basis in 2022 following a growth rate of 13% in 2021 as people continue to use their home for more purposes such as offices, schools and gyms. However, with housing demand weakening, remodeling growth is expected to slow, posting a nominal 5% gain this year and a 4% increase in 2024.
The medium-term outlook calls for single-family home building to lead the recovery later in 2023 and going into 2024, as interest rates fall back on a sustained basis from peak rates. But while demand will return, supply-side issues will become worse – a lack of lots, growing concerns about acquisition, development and construction financing, and building material constraints.
Nonetheless, a structural housing deficit of 1.5 million residences, favorable homebuyer demographics and a better interest rate environment will lead to a solid period for home building during the back half of the decade. Single-family home building will need to exceed 1.1 million starts per year in order to reduce a deficit that arose because of underbuilding in the prior decade.
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