Housing starts aren’t supposed to be falling yet.
Theoretically, higher rates should only impact starts on a lag in a market where the vacancy rate is low.
The logic is straightforward. As Goldman put it earlier this year, “when housing markets are tight, homebuilders are likely to keep building because they have little fear that homes will sit vacant after completion.”
Given that, it was notable that housing starts very nearly matched the most pessimistic estimate for May in data out Thursday. The 1.549 million pace was nowhere near consensus (1.81 million) and represented a sharp decline from the prior month.
The 14.4% drop was the largest of the post-pandemic era (figure above), and took the pace to a 13-month nadir.
This is a noisy series, but it’s nevertheless worth noting that there have only been nine monthly drops larger than May’s going back to 2000. Additionally, starts were 3.5% lower versus May of 2021. That’s not a large drop, and certainly nothing to write home about (no pun intended). Still, every recession going back six decades was accompanied by sharp annual declines in housing starts. The only exception was the dot-com bust.
Both single-family and multi-family starts fell in May, with the former running at the slowest rate since August of 2020. Indeed, single-family starts are on the brink of falling below a one million pace for the first time in almost two years (figure below).
It was the third straight monthly decline and the fourth in five. Multifamily dwelling construction dropped almost 24% from April.
Permits disappointed too. The 1.695 million pace was a 7% decline from April and printed well below consensus.
The data came a day after the latest read on the NAHB index showed homebuilder sentiment dropped to a two-year low in June (figure below).
“The housing market faces both demand-side and supply-side challenges,” Robert Dietz, chief economist at the NAHB, said in a statement this week.
A gauge of future single-family sales dropped further, to just 61 (figure below).
“On the demand-side of the market, the increase for mortgage rates for the first half of 2022 has priced out a significant number of prospective home buyers,” Dietz added.
Notably, backlogs remain robust. The number of homes authorized by not started (both total units and single-family units specifically) continues to loiter at elevated levels, Thursday’s government data showed.
Set against new home sales, the juxtaposition is stark (figure below).
That may suggest America is sitting atop an inventory overhang. If you think that sounds far-fetched considering favorable demographics for the housing market and the notion that supply has fallen woefully short of demand in the post-pandemic era, I’d implore you to consider that market participants said the same thing when a few analysts began to warn about excess inventory at America’s largest retailers early this year.
Outlier concerns over elevated retail inventories were borne out in dramatic fashion last month, when shares of Target collapsed the most since 1987, in part due to inventory concerns.
Speaking of 1987, the latest data from Freddie Mac, released on Thursday morning shortly after the housing starts figures, showed rates rose to 5.78%, a 55bps increase over just one week (figure below).
It was the largest increase since 1987.
“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, in an April note.
Perhaps that rule of thumb (if that’s what it is) needs to be revised. Rates are up 265bps in 2022 and the vacancy rate was 0.8% in Q1. Somehow, I get the feeling every indicator of construction and sales is poised for significant declines, irrespective of how tight the market is.
Homebuilder stocks plunged Thursday, bringing the YTD loss for the S&P Supercomposite Homebuilding Index to an astounding 40%.
Markets are adjusting faster than many are accustomed to – housing is no different. Demand is falling faster than supply can be adjusted. Inventories may be low now, but in 3-6 months they will most likely be signficantly higher. In housing the first step for falling prices is increasing inventory. It is just starting. I expect housing to correct significantly- demographics held up prices better than the financial markets but the downward pull is definitely there. Given what is now going on, it is looking like this Fed hiking cycle is going to be one of the fastest and shortest in history. I don’t expect it to last too much longer. They will be cutting rates in about 6-9 months…..
Great point RIA. Things move so much faster and more violently now, don’t they.
It’s time to update the models and “rules” that street and Fed economists rely on to make sense of the unknowable.
Such as the revered Taylor rule which has been cited by two Fed governors recently. As noted by the folks at Investopedia:
“For many, the jury is out on the Taylor rule as it comes with several drawbacks, the most serious being it cannot account for sudden shocks or turns in the economy, such as a stock or housing market crash. In his research and original formulation of the rule, Taylor acknowledged this and pointed out that rigid adherence to a policy rule would not always be appropriate in the face of such shocks.”
Things change!
I was just envisioning the sheer magnitude of the next round of QE, if (when) Trump becomes president again. Or DeSantis, what’s the difference.
I think the housing bubble has been leaking for some time. Locally, ( and housing markets are like politics – all local ) I have observed banks putting foreclosed properties on the market and then taking them off the market if inflated valuations were not realized. I assumed that the bank’s negative real interest rates were the reason for this. If that is true, it will be very interesting to watch as interest rates rise and the economy collapses. I wouldn’t want to be the last one huffing and puffing to keep the leaking bubble inflated.
There’s no way America doesn’t see a nationwide decline in home prices during the hangover. I’ve heard from mortgage banker after mortgage banker that a nationwide drop isn’t likely, and they all seem oblivious to the circumstances facing their own industry. (I’ve mentioned this before, but I’m considering finally moving away from the island retreat I’ve called home for the past six years. I’m now supremely confident in the odds of finding one, and maybe even two, bargains within 18 months.)
Therein lies the problem. Those with the means to buy a new home or two with cash or a sizable down payment will do so, especially if prices come down just a little bit. Demand isn’t the issue, it’s the lack of supply that could keep home prices relatively stable IMO. I think there is enough pent-up demand that buyers will step in to BTFD regardless of where home mortgage rates are, because the gamble will be that they can refi at a lower rate sometime in the near future if the Fed finds itself battling a collapse of the broader economy.
This year has been a rude awakening, as many realized that the stock market is not a perpetual motion machine that can only go up, but as you so aptly put it in a recent piece but a “Doomsday Momentum Machine” that is now blowing up.
The housing market in the US (and here in Canada) has been no different. Housing markets in cities like Vancouver and Toronto defied gravity in recent years!
Clearly interest rates take a few months for their impact to be fully realized. So I guess it is the market psychology and home buyers psychology are both changing fast! The bubble is deflating and/or may soon burst!