smallamerican springJust around the corner, bringing with it many fine traditions. Cracks from a bat on a baseball field. Children roll Easter eggs on the White House lawn. Families sell dusty old furniture in the yard. Still, there is one ritual that stands above all others in its sheer financial importance: the spring selling season, when the housing market recovers — or in rare cases fails to recover. It may be the biggest determinant of the global economic outlook for the rest of the year, with a recession on the one hand and the softest landing on the other.
Your browser does not support
The importance of US housing is not in its sheer size, although its total value is about $45 trillion. Instead, it serves as a bellwether for how the economy is doing during periods of rising interest rates. Will the Fed hike rates enough to calm inflation without dampening growth? Is it going too far? Or, maybe not enough? As one of the first and largest industries to respond to change, the real estate market offers some answers.
Until last month, the evidence seemed straightforward. Even before the Federal Reserve started raising policy rates, mortgage lenders, anticipating a tightening by banks, were already charging higher fees. From 3% at the end of 2021, the 30-year fixed mortgage rate exceeded 7% in October, the highest level in more than two decades. Lo and behold, the activity quickly ceased. Buyers are staying on the sidelines. Builders scaled back new construction projects. discount by seller.
More recently, however, there have been early and largely unexpected signs of a rebound, raising concerns that rate hikes have not had the desired effect. New home sales jumped to a 10-month high in January. Surveys measuring confidence among homebuilders and homebuyers improved. Real estate companies in the U.S. are reporting an increase in visitors to their show homes. “We’re seeing this build up week in and week out,” said Sheryl Palmer, chief executive of Taylor Morrison, one of the largest U.S. homebuilders.
The reason for optimism is that the US housing market has found its bottom. Buyers are returning, but the covid-era frenzy is not. In theory, a decent spring could allow prices to stabilize and builders to resume construction, boosting growth without stoking inflation. The reason for pessimism is that the interplay between the housing market and inflation trends is too strong to ignore: if buyers return to supply-constrained housing markets, prices will follow. And if the Fed sees that a rate-sensitive sector like housing is not responding to tightening monetary policy, it may judge that it needs to be more hawkish. Unfortunately for America and the world, a pessimistic scenario looks more plausible.
Analysts pointed to a number of factors behind the rebound. There is pent-up demand after a year of tepid sales. Wealthier buyers paid in cash, representing a larger market share. Buyers may also be used to higher rates: When mortgage rates fell to 6% in January from more than 7% late last year, some saw it as a good deal.
Perhaps most critically, developers have created a series of incentives. There is nothing unusual about using discounts when the market is volatile; the new element this time around is the aggressive use of mortgage repos by in-house lenders, effectively prepaying some interest on behalf of customers to lower mortgage rates. This has allowed developers to offer mortgages that appear to have originated in the pre-inflationary era of the 2010s. Homebuilder Pulte is pricing some of its near-completion properties on 30-year fixed rates at just 4.25%. Another builder, Toll Brothers, is offering 4.99%. “We learned a lot in the last year about how to address consumer concerns,” Ms Palmer said.
These discounts are a neat trick of financial engineering. Real estate consultant John Burns points out that paying 6% upfront on a mortgage and getting a lower rate for the remainder of the term is just as beneficial to homebuyers as lowering their home price by 16% but getting them a higher rate. That’s a huge savings.
The obvious question is whether this discount is sustainable. There are two potential obstacles. It is difficult for homebuyers to resell their homes for the same price to buyers who did not benefit from mortgage repurchases. As a result, Mr Burns believes valuers may reduce contract home values, which will force sellers to lower their prices. Second, buyouts kick in in the face of what the Fed has been trying to do: curb real estate purchases to bring demand and supply into a better balance.
Last year, Federal Reserve Chairman Jerome Powell talked about the need for a “little reset” in the housing market. In terms of affordability, this reset has yet to run its course. Mortgage payments on new homes now account for nearly 30 percent of average U.S. household income, nearly double the average in the 2010s. Rising incomes, falling mortgage rates, or falling home prices will bring affordability back to pre-pandemic levels. All three are starting to happen, but there is still a long way to go. Nationwide, home prices have fallen just 4% since peaking in mid-2022, barely offsetting a 45% rise during the pandemic, according to the statistics. Second&p CoreLogic Case-Shiller Index.
There is a more inflexible part of the equation: housing supply. Homeowners locking in low rates are reluctant to move. There are only 1.1 million existing homes on the market for resale, half the average since the late 1980s. Meanwhile, on the eve of the global financial crisis, homebuilders are more cautious than they were two decades ago. When the COVID-19 buying frenzy kicked in, home construction picked up but didn’t soar because developers thought the boom was short-lived. Then, when the market softened, they scaled back their activities almost immediately.
This is good for builders’ balance sheets, leaving them with large cash positions. But it’s bad news for everyone else. Investment in residential construction actually fell by a fifth last year. It looks like there will be further declines this year. Strikingly, new starts have declined so far, even as demand has only just begun to rebound.Dawar Joshi bca A decline in housing investment of a similar magnitude has almost always heralded a recession in the past, the study noted. Robert Dietz of the National Association of Home Builders shares the same concern: “You never really have a period where prices are down and residential investment is down significantly, and a recession doesn’t happen.”
That runs counter to financial markets’ hopes that the U.S. can avoid a recession, and housing markets’ hopes that the worst is behind us. Businesses, economists and investors have learned over the past two years to be wary of false inflation: brief inflationary pullbacks give way to renewed price pressures. The housing recovery could also prove to be false, with the sector’s fundamentals weaker than it appears and the Fed forced to keep interest rates higher for longer. A lot depends on the spring selling season. ■
Illustration: Timo Lenzen
For more expert analysis of breaking economic, financial and market news, sign up for Money Talks, our subscriber-only weekly newsletter.
