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%.