The decline in housing numbers reported for December on Wednesday is tied to the dwindling available supply of housing for purchase.
Pending home sales reported by the National Association of Realtors through December 2019 decreased 4.9% month over month; however, the year-over-year comparison shows a 6.8% gain on an unadjusted basis. While low unemployment and modest wage growth are driving strong demand, housing inventory is lacking.
The increase in permits and a change in strategy by major homebuilders to new affordable entry-level homes in 2020 should help with supply constraints, but existing home sales are lacking. The driving factor may be historically low interest rates, which bottomed out in late 2012. The typical homeowner looks to move in eight to 10 years, and looking back, interest rates in 2012 were at 3.64%. In 2020, many move-up buyers are locked in at low rates and not incentivized to move into more richly priced housing at higher mortgage rates later on in the economic cycle. This has resulted in a depressed existing home inventory of 1.22 million homes.
On the supply side, single-family housing starts have risen more than 100% since bottoming out in 2011, but are well below the long-term annual average to replace aging housing stock. Adding insult to injury, construction of single-family homes has just barely kept pace with household growth for an unprecedented eight years. Looking forward, contract signings of 699,000 on an annualized basis—a high for this economic cycle—signal that the pipeline of demand for new homes is robust. During earnings calls this week, public homebuilders painted the picture: Pulte signaled that order volume is the highest in a decade; KB Homes reported that supply continues to be insufficient to meet homebuyers’ needs; DR Horton said first-time homebuyers made up half of mortgage company closings.
At 3.81%, the contract rate for a 30-year fixed mortgage continues to be at multi-year lows, which is supportive of a continued stable demand environment. Additively, loan applications to buy homes increased to their highest level since 2009, suggesting that home sales going forward will continue to stabilize. The Mortgage Bankers Association is also showing that its overall indicator of applications is the strongest it has been since 2013.
Limited downside risk
In the recent past, 2018 and early 2019 proved to be volatile for the housing market with interest rates climbing as high as 4.94%, significantly impacting affordability for home buyers, especially at the entry level.
While the Federal Reserve is expected to remain on hold with its interest rate policy for the duration of 2020, the continued slower pace of growth globally and domestically coupled with a black swan event like the coronavirus outbreak may spur action on a rate cut later this year. A sustained low rate environment will be a broad positive across all homebuyer segments and specifically for the most rate sensitive buyers at the lower end of the market.
Any downside risk for homebuilders in an eventual recession is limited especially as the industry continues to under build relative to demographics. Supply side constraints, including high cost of land and labor, will continue to keep growth in check and avoid any scenario even remotely close to the downturn in housing experienced during the Great Recession.