New Housing Outlook: Higher Risk/Higher Reward

Trends and challenges in today’s housing market, though they may be risky, they can mean for high reward

By Christopher Thornberg

Activity in both the new and existing home markets has always moved in close tandem, given that the two markets overlap in so many ways. As such, the last two years must have been a pleasant surprise for homebuilders. While sales activity in the existing United States home market has been driven into a deep chill by the sharp increase in mortgage rates, the new home market has shown remarkable resilience. New home sales and overall permitting activity are only down modestly from the post-pandemic surge and are still above the post-Great Recession slump.

The story of the current odd housing market started pre-pandemic, in the period of ‘miserabilism’ that followed the Great Recession. Low interest rates during that time meant that housing affordability rose to all-time high levels, despite many narratives to the contrary. But general pessimism about housing (does anyone remember the ridiculous predictions of falling home prices in 2019?) kept both buyers and builders on the sidelines for most of the expansion, which had the perverse effect of reinforcing the pessimism. 

The pandemic stimulus didn’t just breach that dam, it blew it up, and pent-up demand flooded into an already tight housing market. Inventories of new and existing homes plummeted, causing home prices to skyrocket. This caused equity levels in existing homes to surge, driving more demand for new housing. Builders have been trying to catch up ever since. 

With so few people selling, the filtering process is not working well; builders looking to sell new housing must try to locate that housing in a place where there is mobility and a plentiful supply of new buyers.”

Now should be a golden age for builders—but there are challenges. With explosive prices and inflation, the Fed did a U-turn on its loose monetary policy in an attempt to off-load its $9 trillion balance sheet. Interest rates rose to meet the federal funds target (effectively raised from 0% to 5.33%) which had the desired effect of easing inflation, but also sent mortgage rates into the seven percent range. And this is a real problem for builders and real estate professionals. The existing home market today is not cold because of a lack of demand, but because of a lack of supply; too many homeowners are unwilling or unable to trade their current 30-year fixed-rate mortgage for a new one at a much higher rate. In 2010, the problem in housing was not enough buyers—today there are not enough sellers. 

This has made things more challenging for builders. New construction typically relies on filtering—where homeowners sell their older home for a brand new one. But with so few people selling, the filtering process is not working well; builders looking to sell new housing must try to locate that housing in a place where there is mobility and a plentiful supply of new buyers. Part of the demand will come from first-time homeowners. Zillow’s 2023 Consumer Housing Trends Report shows that the proportion of first-time home buyers has been going up in the last few years. First-timers made up 50% of all home buyers in 2023, up from 45% in 2022 and 37% in 2021. The inventory of homes for sale has risen to relatively high levels, even though overall sales and permitting activity is also still running at a high level. If you’re in the right place with the right product, it will sell, if not, it won’t. Today’s housing market is high risk, but also high return. 

Beacon Economics doesn’t see this situation changing soon, albeit the severity will ameliorate over time. We have been clear that when it comes to long-run interest rates, the right forecast is higher/longer. We expect mortgage rates to stay above 7% for the near future. The Fed still has a massive balance sheet to offload through quantitative tightening, and the Federal budget deficit will not be closing anytime soon, which will put downward pressure on bond markets. Any cuts in short-run rates will only unwind the yield curve. A backlog of would-be buyers is playing a waiting game, with many looking for even small declines in interest rates to jump into the market—even if rates are still relatively high. 

Housing demand will rise with population growth. Increasing incomes should gradually improve affordability, allowing more people into the ownership market. An aging America will require more housing despite slower population growth. The Congressional Budget Office (CBO) projects the U.S. population to reach 383 million by 2054, with immigration playing a key role. Stronger immigration trends in recent years, noted by CBO data, highlight the ongoing need for housing.

Christopher Thornberg is the founding partner of Beacon Economics. Learn more at www.beaconecon.com.