Mr. Powell, Tear Down This Housing Bubble!

US housing starts and building permits fell in April, data out Wednesday showed.

Markets are on high alert for signs of a slowdown in America’s property market, which delivered a massive windfall to homeowners during the pandemic, as monetary largesse and an acute supply-demand imbalance drove stratospheric price gains.

Starts fell to a 1.724 million annual rate last month, The Commerce Department said. That was slightly below the expected 1.756 million pace, but still elevated (figure below). Permits beat slightly, but the 1.819 million annual rate was the slowest since November.

Revisions meant April marked the second consecutive monthly decline and the third in four. The range of estimates, from five-dozen economists, was 1.651 million to 1.815 million.

Recall that last month’s data was skewed towards multifamily construction. Single-family starts, permits and completions all fell, even as the pace of single-family starts remained above 1 million for the umpteenth consecutive month.

In April, single-family starts dropped again. But, the 1.1 million pace was enough to extend the streak (figure below).

The MoM decline was the largest in a year. Backlogs were the highest in nearly a half-century. Properties under construction hit 815,000.

The update came a day after data showing homebuilder sentiment slumped for a fifth month to the lowest in almost two years in May (figure on the left, below). “The housing market is facing growing challenges,” Robert Dietz, chief economist at the NAHB, said in a statement, citing a 19% annual increase in the cost of building materials and the rapid rise in mortgage rates.

Notably, the NAHB gauge of future single family sales dropped to 63, the lowest since January of 2019 if you strip out the initial months of the pandemic (figure on the right, below).

“Based on current affordability conditions, less than 50% of new and existing home sales are affordable for a typical family,” Dietz went on to say, adding that “entry-level and first-time home buyers are especially bearing the brunt of this rapid rise in mortgage rates.”

I’ve said it over and over again: “Median” households don’t buy things that cost a half-million dollars in the first place. When the cost of financing rises sharply, what was already a ludicrous proposition becomes positively insane.

The Fed is now engaged in an effort to cool prices for a few reasons, not least of which is the impact on inflation, as illustrated so poignantly by the familiar figure on the left (below).

Of course, this is ironic because the Fed is partially responsible for creating the problem it’s now struggling to correct (figure on the right, above).

There are knock-on effects that concern the Fed as well. Much like the run up in stocks and cryptocurrencies, quarter after quarter of trillion-dollar gains in property prices (figure below) disincentivized work, and likely contributed to early retirements.

Arguably (it’s actually not arguable, but we’ll pretend), minting millionaires by engineering an overnight bonanza in the housing market had a structural impact on the labor force.

Let’s say you owned a home that was worth $400,000 pre-pandemic, and you had $1 million squirreled away in a retirement fund heavily weighted to equities. The post-pandemic surge in both home and stock prices likely compelled you to at least consider early retirement, assuming you were somewhere near it anyway. A back-of-the-envelope estimate suggests you’d be at least 50% richer.

Making millions of already well-off people 50% richer in the space of 22 months invariably means less workers. That, in turn, means a tighter labor market. And a tighter labor market means wage pressure. And if wage pressure doesn’t abate, it means higher consumer prices as corporates attempt to protect bottom lines.

“The housing market is looking increasingly vulnerable with a price correction possible,” ING’s James Knightley said. “This would weaken confidence but would contribute to inflation falling more rapidly and allow the Fed to move to a more neutral position.”

“Moderation in the pace of gains in the real estate sector is surely a desired outcome for the Fed — if not a stated policy objective,” BMO’s Ian Lyngen wrote.

Separate data out Wednesday showed MBA mortgage applications dropped 11% in the week ended May 13. It was the first drop since April 22.

As a reminder, higher rates likely won’t impact housing starts when the market is still tight. “A 100bps increase in mortgage rates slows housing starts by 13% when the housing vacancy rate is above 2% but starts are essentially unresponsive to changes in mortgage rates when the vacancy rate is below 1%,” Goldman said last month. The figure on the right (below) illustrates the point.

“When housing markets are tight, like they are today, homebuilders are likely to keep building because they have little fear that homes will sit vacant after completion,” Goldman went on to write, in the same note.

In the color accompanying this week’s mortgage apps data, Joel Kan, MBA’s Associate Vice President of Economic and Industry Forecasting, didn’t mince words.

“Prospective homebuyers have been put off by higher rates and worsening affordability conditions,” he said. “Furthermore, general uncertainty about the near-term economic outlook, as well as recent stock market volatility, may be causing some households to delay their home search.”

Commenting further on Wednesday, ING’s Knightley gently suggested that the supply-demand picture could be materially different by year-end. “Starts and permits fell in April, but both remain in a strong upward channel and point to more housing supply hitting the market later this year at a time when demand is potentially dropping off quite quickly,” he remarked. “Hence our belief that the rapid price appreciation of housing could quickly flatten out and possibly reverse.”

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