A worker drills plywood on a single-family home under construction in Lehi, Utah, Friday, Jan. 7, 2022.
George Frey | Bloomberg | Getty Images
The once-red-hot housing market is cooling at an alarming rate, and some developers say it will only get worse in the new year as new orders dry up.
The rapid rise in mortgage rates has left once frenzied homebuyers excited and worried about their potential investments and the health of the economy as a whole.
“There’s a cliff in January,” said Gene Myers, CEO of Thrive Homebuilders in the Denver area, which was one of the hottest markets in the years before and after the coronavirus pandemic.
US homebuilders have been the main beneficiary of the Covid economy. Record-low interest rates, combined with frenetic demand from consumers looking for more living space, have sparked a housing rush the likes of which most have never seen before. House prices rose by more than 40% in just two years, and developers couldn’t fill orders fast enough. They even slowed sales to keep up. It’s all over.
Housing starts for single-family homes fell nearly 19% in September compared to the same period last year, according to the US Census. Building permits, which are an indicator of future construction, fell 17%. PulteGroupone of the country’s largest homebuilders, reported that the cancellation rate jumped from 15% in the second quarter of this year to 24% in the third.
Public homebuilders that have reported earnings so far have posted surprisingly strong results, but that’s because much of that is based on a backlog of homes that went under contract last spring. This was before mortgage rates went over 6% and then 7%.
Now the builders are preparing for what will happen next. Myers said his company’s balance sheet is now incredibly strong, thanks to a backlog of homes sold at high prices, but he predicted the market will be “ugly” until early next year.
“It’s definitely a tough landing for housing and communal services,” he said. “Any hopes of a soft landing really disappeared last spring when it became so clear that our customers, who were used to such low mortgage rates, were simply going to go on strike.”
Myers was around during the last housing crash, which was caused by a broken mortgage market where almost anyone, qualified or not, could get a home loan. This led to a massive housing collapse based almost entirely on speculative buying and selling by investors. Single-family housing starts fell a staggering 80% from January 2006 to March 2009, but Myers notes that this was a slower turnaround than what is happening now.
“I think we’re seeing the most dramatic change in the market in my career, and I’ve been here for a while,” he said. “I’ve never seen sales just stop, which is what happened for us in May.”
A downward spiral
Even six months ago, the number of single-family housing constructions still increased by 10% compared to the same period last year. This was just before mortgage rates really started to skyrocket. Going from 10% annual growth in construction to a 19% decline over that time is a historically sharp turnaround.
While new construction sales are down, prices are still higher than last year. This is largely due to the still inflated prices for labor and materials. In part, the increase in prices may indicate which houses are being sold, namely the more expensive ones. But that could change soon, too.
Cheryl Palmer, CEO of an Arizona homebuilder Taylor Morrison, which just reported strong third-quarter earnings, said entry-level buyers are clearly struggling. But she also acknowledged that higher-end buyers are no longer flocking in the door either.
“When we look at our growth and our resort lifestyle buyers, they can still afford to buy, but emotionally you need to have confidence,” Palmer said Friday on CNBC’s “Crazy Money.” “Even at today’s rates, both our FHA and regular buyers have a lot of options, but just because they can afford it doesn’t mean they have confidence given everything that’s going on in the economy today.”
Palmer told analysts on the company’s earnings call that new orders fell “sharply” in September and that the slowdown was felt across price points, regions and consumer groups. As a result, Taylor Morrison is halting investment in land, reducing the pace of new construction starts and offering additional incentives to buyers.
According to the National Association of Home Builders, sales of newly constructed homes fell below pre-pandemic levels in September, and the number of cancellations is now double what it was a year ago.
“This will be the first year since 2011 that the number of single-family businesses has declined,” NAHB Chief Economist Robert Dietz said in a release. “While some analysts suggest that the housing market is now more ‘balanced’, the truth is that the level of home ownership will decline in the coming quarters as higher interest rates and persistently high construction costs continue to reduce the price for a large number of potential buyers . “
The supply of newly constructed homes remains elevated, in contrast to the existing home market, where listings remain scarce. NAHB reported that a quarter of builders are now cutting prices.
And this is a great unknown. Prices for both new and existing homes are cooling, but analysts are divided on whether they will actually show year-over-year declines and how wide those declines might be. Myers said he has heard talk of a 20% reduction in new construction prices.
“And this sounds really harsh, but when we look back, because our construction costs have gone up so fast, we only need to add a little over a year to be 20% less than we are now,” Myers said. “So to think that we’re just going to go back to 2020 doesn’t sound as crazy as a 20% price correction. But I think it absolutely has to happen if we want to get the speed back. “
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