The B&D Interview: Bob Dietz, Chief Economist, National Association of Home Builders
Industry expert discusses the 2024 housing market outlook, builder challenges and what they need to do for a successful year
Builder and Developer: After a past year of ups and downs and uncertainty, what do you think is in store for 2024?
Bod Dietz: We’ve now had two years of decline for single-family starts. The market was down about 11% in 2022 as the Federal Reserve began to tighten monetary policy, which of course ultimately led to interest rates flirting with an 8% level. Those elevated rates brought single-family starts down in 2023. When all the final data are in and revised, we’re probably looking at about a 9% decline in 2023.
Now that we’re almost past peak mortgage interest rates for the cycle, and, on Dec. 7, 2023, Freddie Mac indicated that over the last week, mortgage rates averaged just about 7%. So we’re down almost 100 basis points. Combine that with an expectation of a slowing economy, and likely an interest rate cut or two from the Federal Reserve during the second half of next year, all those factors are going to improve for-sale housing demand, and therefore we’re forecasting single-family starts to be up almost 4% in 2024. In 2025, increasing more than 8% and ultimately, we’re thinking about over the next four to five years, our analysis indicates that single-family starts will get somewhat above 1.1 million starts per year, which is the level at which we need to be building to significantly reduce the housing deficit that exists in the country, which we estimate totals 1.5 million homes.
The recovery will have some stops and starts. The skilled labor shortage is a factor and lending remains tight for smaller private homebuilders. The average annualized interest rate on a construction loan right now [at the time of print], is 14%. Those high-interest rates are also affecting the land development market, which means later in 2024 and 2025, we expect lot availability to tighten, which will be another challenge.
We still have issues in the building materials space. Distributional transformers are in short supply now, an industry issue of which 80% of homebuilders report delays connected to those transformers. And while we’ve seen some relief concerning softwood lumber, prices peaked at about $1,500 per 1000 board feet in early 2021 They’re now back below $400 per 1000 board feet, which is pretty close to where we started pre-COVID. As the volume of single-family homes under construction begins to increase on a sustained basis in 2024, there remains some friction in the lumber market. There’s a 9% effective tariff rate in Canadian softwood lumber – where we get a third of our lumber supplies. In addition, the domestic supply is not sufficient for what the industry needs, and I think we can risk some increases in current levels of lumber prices.
The last factor that will present a challenge to some of the growth for single-family construction is ongoing regulatory issues. Delay effects in terms of approval projects, ongoing challenges with zoning rules, minimum lot size requirements and other kinds of regulatory rules that make it more expensive to build housing than it really should.
Multifamily construction will post a decline this year after a gain last year. That decline will be steeper in percentage terms in 2024. We’re expecting about a 17% decline in multifamily construction. Talking to apartment developers, putting aside the forecasting and the economic modeling, a lot of apartment developers are expecting a steeper decline. That’s because financing conditions have become so challenging concerning apartment development.
On the economic side, there are one million apartments currently under construction. As those units turn into completed units, the supply of apartments will rise, which will produce an increase in vacancy rates in some markets. It will certainly slow down rent growth. Those factors would naturally cause apartment development to slow. So we don’t see a gain for apartment development until 2025. That’s when the multifamily market will begin recovery from the declines produced by tight financial conditions.
The remodeling market. It’s had some really strong years following COVID-19 work from home, aging housing stock and aging in-place remodeling are all factors that help the remodeling market. Single-family and multifamily sentiment indicators show weakness and concerns about market conditions, while remodeling remains positive. We expect relatively flat conditions for this year and next, and then growth in remodeling in 2025, but no big decline. It’s more of a leveling-off process. And again, that’s just because the amount of demand for reinvestment in homes, whether it’s for energy efficiency purposes, improving resiliency or just the traditional kitchen and bath type cosmetic elements are all important when it comes to the growth and remodeling market.
Lastly, in terms of thinking about the macro, as I said, we expect that the Federal Reserve will likely cut the Fed funds rate, which is the rate that they control, once or twice during the second half of 2024, but until then there’ll be pursuing this “higher for longer” monetary policy strategy. We do think long-term interest rates will move lower, even while short-term interest rates will remain elevated.
The good news is that inflation will continue to come down. It’s going to take some time to get to the Fed’s 2% target, but one of our messaging points to policymakers is that the fight against inflation doesn’t have to be an undertaking for the Federal Reserve. Legally, of course, they’re responsible for maintaining price stability or fighting inflation. But when we look at the more recent data points on inflation itself, like the Consumer Price Index (CPI), the majority of the gain in CPI has been due to increases in shelter inflation, which is the cost of rent and homeownership. So we’re thinking about policy tools and market developments that can be used to bring inflation down. I would argue what’s most important is providing an additional supply of attainable, affordable housing both for sale and for rent. If we build more, there’ll be more supply, and that will help tame the shelter inflation component of the CPI and bring the rate of inflation more rapidly to the Federal Reserve’s target.
2024 and 2025 are going to be years of rebound and expansion. Then the back half of this decade looks like a pretty good runway for homebuilding growth.”
B&D: What are your interest rate predictions?
BD: The expectation on our model right now is that by the fourth quarter of 2024, we think the 30-year fixed rate mortgage will have declined to about a 6.5% rate. We’re looking for mortgage rates just below 6% by the time we get to the middle of 2025. In our current forecast, mortgage rates peaked around late October of 2023, near 8%. That is higher than what we expected.
The run-up in rates in September and October took us about 50 basis points above the forecasts that we had had in place at the start of the year. Those two months had some technical factors in the bond market that led to a sell-off. Some additional concerns were beyond typical inflation and Federal Reserve issues. The federal government, for example, ran a larger deficit than expected. The result was there were ever more bonds on the market, which required higher interest rates to attract buyers. Generally speaking, however, the factors that are going to push interest rates down will be slowing gross domestic product (GDP) growth.
In fact, over the next few quarters, we expect GDP growth to be in each quarter to come in about the 1% annualized rate range. We could see a quarter where GDP growth is closer to zero, but not any negative quarters.
Keep in mind for the first and second quarter of 2022, GDP growth was negative. In a sense, the overall economy is going through this rolling recession, which you can characterize as a soft landing if you want to look at it from the more more positive perspective, but a rolling recession is one in which there is a period of some GDP decline, that’s in the rearview mirror, and then one in which individual sectors of the economy experience softness at different periods. For housing in the third and fourth quarters of 2022, we had, roughly speaking, a housing recession with declines and certain kinds of activity levels. We had an additional smaller period of decline in September and October 2023, but now with rates pulling back, that’s good news.
The other interest rates to keep in mind though are the interest rates for construction and development loans for non-publicly traded builders, which remain elevated. We’re seeing construction and development loans at a 13% to 14% annualized rate basis right now.
One of the concerns is that housing demand will come back as the 30-year fixed-rate mortgage moves below 7%. And it’s possible that the inventory of lots will not be sufficient to meet the rising demand for new construction. That is an important point because all of this is being shaped by the housing deficit.
Existing home sales continue to fall, even as new home sales go up. The reason why is there’s just not enough inventory in the resale market. I would argue that the amount of resale inventory for single-family homes is about half of what it should be. We’re looking at a month’s supply measure somewhere between three and four months. As a result, new construction, when the demand is there in the market, has to fill the gap. For example, right now, about a third of homes that are available for sale, are newly built homes. That’s an elevated share compared to the sort of historic norm of about 12%.
The remarkable thing is, if you had said, I think to most housing economists or most industry analysts in our sector, five or six years ago, “You know, we’re going to go through a rate cycle where mortgage rates will go from historic lows below 3%, and they’re going to increase to almost 8%. What would be the impact on home prices and homebuilding?” If you had asked that question at that time, the results would have been pretty devastating; significant declines, and homebuilding activity beyond what we experienced, home price declines that would be reminiscent of the Great Recession itself. And of course, with home prices now, we haven’t seen that.
Builders have had another advantage in terms of using mortgage rate buy-downs and other kinds of incentives. We estimate that about 60% of homebuilders are utilizing some kind of incentive to deal with, essentially, multi-decade lows and housing affordability. But the lack of inventory has been the insurance policy that’s kept homebuilding activity declining further than it has.
All this occurs in an environment where the aggregate measures of residential construction materials are 30% to 35% more expensive than they were pre-COVID. Dealing with those kinds of cost changes, with the dramatic movements of housing demand stimulated by historically low-interest rates right after COVID and then the shock to the system in 2022, the industry has proved to be fairly resilient and stable. Admittedly with two down years for single-family homebuilding, though from a pure academic perspective, things could have turned out worse.
B&D: What challenges exist for builders entering the new year?
BD: Local market conditions vary. The areas of the country that we expect ongoing growth as we move into more of a rebound mode will continue to be those areas that have benefited from gains, population and jobs, which would be the South. More than half of single-family homebuilding is in the South. The fast-growing, but smaller metropolitan areas of the Mountain States are good examples. There are pockets of strength in the Midwest markets like Columbus, Ohio and Indianapolis. With these varying local market conditions, builders need to judge those characteristics.
Even within individual metro areas, there are geographic differences. For example, the urban cores, which are the downtown areas, are relatively weak and are having an impact on the amount of multifamily construction that’s been undertaken. It’s resulting in more outer-suburb and exurban multifamily construction, more two- to three-story wood-framed apartment buildings and fewer high-rise steel and concrete. That geographic effect of shifting demand out is affecting single-family construction as well.
We’ve seen gains for exurban and outer-suburb development, some medium-density improvements for single-family homebuilding with townhouse construction right now at roughly 17% of single-family starts. That’s a multi-decade high, and we’ll continue to see gains for townhouse construction in areas that are zoned for that more walkable type of housing. There are luxury townhouses, of course, but townhouses are a great way to build entry-level-type housing, given the fact that they require less land than other kinds of housing.
For challenges, what’s going to happen is as demand gets pressed back in, we’re going to face the same kind of supply-side headaches that have essentially limited the amount of construction undertaken by the industry over the last decade. In years past I called these challenges the five “L”s. It’s a lack of labor, lack of lots, lack of lending to builders and developers, loan issues with lumber and building materials and then legal and regulatory cost burdens. Those five health factors remain in the industry. From an advocacy perspective, the industry, working through the state homebuilder associations and the National Association of Home Builders (NAHB), efforts need to be focused on making progress on all of those supply side factors.
One thing we warn policymakers and academics is that you simply can’t fix one of these things and then expect a real acceleration of homebuilding activity. For example, you might have a think tank or policy analyst who is focused on zoning reform. We’ll make the argument that if we liberalize or make zoning rules more flexible, we’ll build more housing. Well, yes, that’s true, but if suddenly you have an increased demand because you’ve improved your zoning rules and lot development pipeline, you’re still going to need additional skilled labor to build those. In any given month, the industry is short 300,000 to 400,000 construction workers, so we’re working on workforce development. As I like to put it, “we need to recruit, train and retain workers in the sector.”
Productivity in the sector has been relatively flat compared to the rest of the economy. Residential construction productivity is only up about 13% over the last 30 years and for the overall economy, it’s up 50%. A lot of that has to do with higher regulatory costs, it’s just more difficult to build things. It also speaks to the need to make our workforce more productive. That’s going to be a challenge because as we recruit younger workers, they’re initially going to be less skilled, and productivity in the sector will likely go down before it goes back up. So, zoning reforms, workforce development and making sure that builders and developers have access to credit, improving the supply chain including lumber and then just fighting the nonsense rules when it comes to regulatory costs because we continue to estimate that for the typical single-family home, about a quarter of its final sale price applies to regulatory costs. These are all of them added up, and they make housing more expensive. So when it comes to the regulatory fights, I like to say, “We need to work with the YIMBYs, we have to convince a significant number of the NIMBYs and then we’re going to have to fight the bananas.” The bananas are the “build absolutely nothing anywhere near anything or anyone,” and they’re just outright opposed to any kind of new development.
B&D: In terms of research and economics, what’s next for NAHB?
BD: We’re continuing to expand our geographic analysis. Some of the data that we look at to try to track is how urban core areas are doing versus inner suburbs, versus outer suburbs, exurban markets and rural areas. There are a lot of different data shops, you’ve got groups that will look at a lot of supplies, building activities and serve markets, but we want to get some of these big-picture geographic changes, particularly after COVID.
We will continue to be engaged with the Federal Reserve and other policymakers to make sure they realize the scope of the housing deficit and continue to make the case for those policy options that will allow the industry to provide as much housing as possible. Particularly as the millennials in their mid to late 30s move into their 40s and try to achieve homeownership. That’s a cooperative effort with the lobbyists at NAHB working with our team, and the economics group working with those lobbyists.
We’ve got a lot of regulatory issues in front of us. For example, we’re gonna see whether or not new homebuyers who are using Federal Housing Administration mortgages or potentially even mortgages backed by Fannie Mae and Freddie Mac, will have to purchase new homes that are tied to certain kinds of energy code requirements, which could certainly price out a lot of potential buyers.
B&D: Is there anything else you would like to add?
BD: We’re watching other markets. Single-family build-for-rent got approximately triple the market share, so it’ll be interesting to see how that market evolves. We’re also watching the townhouse market. And new home size is falling, which will probably continue, particularly as we add additional entry-level construction.
Zooming back and kind of the last big picture of a conclusion from this is that 2024 and 2025 are going to be years of rebound and expansion. Then the back half of this decade looks like a pretty good runway for homebuilding growth. Again, it’s going to be about building out that housing deficit. The demographics are really in favor in terms of single-family construction, because of the millennials. The 2030s are probably going to be more challenging as household formations slow, we won’t go into the details, but we’re likely looking at the 2030s being a decade with higher interest rates, potentially higher tax rates and maybe higher inflation rates. So 2030 is going to be more challenging. The back half of this decade looks like a set of promising years for the homebuilding industry.
