- The housing market, while strong, is hampered by limited supply.
- Home affordability is set to be challenged by rising interest rates.
- Builders continue to be constrained by the limited supply of materials and their rising costs.
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The spring housing market might not be as hot as it was a year ago, but it remains very competitive. One of the most significant drivers is the continued adaptation of work patterns to hybrid and remote environments. This trend has shifted homeowners’ buying preferences, with many prioritizing more space over proximity to the office. Additionally, solid market fundamentals such as favorable demographics and low interest rates have further exacerbated the surge in demand for housing and point to its staying power.
Another important catalyst is the push by the millennial generation into homeownership. According to the National Association of Realtors, the median age of a first-time home buyer is 33, the highest on record. Millennials—currently aged 26 to 41 and making up nearly a quarter of the U.S. population—accounted for 37% of total home purchases (both single-family and condominiums), the highest share of buyers among generations, according to mid-2021 data from online real estate marketplace Zillow. Despite being the largest group of purchasers in America, many millennials find themselves priced out of their local markets due to limited inventory. The NAR’s housing affordability index dropped to 151 in the third quarter of 2021 from 168 a year earlier, with the first-time buyer index touching 99, down from 111. A value of 100 means that a family with the national median income has exactly enough income to qualify for a mortgage on a mid-priced home; anything below 100 means they are less able to afford the median home.
Further challenging home affordability are rising lending rates, with the Federal Reserve expected to institute three rate increases in 2022. Even though Freddie Mac reported 30-year fixed mortgage rates have risen recently to more than 3%, overall they remain near all-time lows. However, the expected higher cost of capital as the central bank rate hikes kick in, combined with the ultra-low inventory of available homes, could discourage buyers from entering the market, especially if prices remain elevated.
Despite these headwinds, housing still has room for growth. Michael Murray, chief operating officer at homebuilder D.R. Horton, noted on the company’s fourth-quarter earnings call in November, “I think it’s pretty clear that the market is not as white-hot right now as it was in the spring, but we’re still seeing very strong demand and the homes that we’re releasing for sale are still being absorbed quite well, with historical low levels of incentives in place.”
Supply challenges
Builders, meanwhile, are facing supply-side challenges that limit their ability to increase depressed levels of home inventories. The development of new pandemic variants, along with wildfires on the West Coast and in Colorado and British Columbia, as well as flooding in British Columbia, have posed significant challenges to already fragile supply chains. Materials, most notably lumber, remain scarce and prices are volatile; the cost of lumber has resumed its upward trajectory, with lumber futures reaching $1,133 per thousand board feet as of Jan. 4, nearly triple their price in August 2021. A recent study by the National Association of Home Builders estimated that the higher cost of lumber has added $18,600 to the price of a new single-family home and $7,300 to a new multifamily home, on average. Further volatility in prices will continue to have an impact on affordability.
In addition, recent trends such as the proliferation of online home flippers known as iBuyers and the entry of homebuilders into the single-family build-to-rent market are also limiting the supply of homes.
iBuyers, which use technology to simplify the home-selling process, have grown significantly over the last year. They purchase homes directly from the seller, eliminating the need for an agent, make light repairs and then resell. A recent study by Bloomberg found that 2 out of 10 homes sold by iBuyers are sold to investors and never get listed, further limiting available inventory and squeezing retail customers out of the competitive housing market.
A growing build-to-rent market
The single-family build-to-rent market has also attracted significant interest and capital investment. With homeownership in the United States expected to decline from the current 66%, builders are looking to provide more options for those not ready to buy.
D.R. Horton and rival homebuilder Lennar recently expanded their build-to-rent operations and expect to continue growing both single- and multi-family options in 2022. On its recent earnings call, D.R. Horton indicated it expects to grow rental platforms by more than $1 billion in fiscal 2022 and is positioning the segment to be a big contributor to revenue going forward. Higher investments in build-to-rent operations can help homebuilders diversify their operations and mitigate risk.
Absent more coronavirus variants or other natural disasters, supply-chain issues are expected to ease over the coming months, giving much-needed relief to builders. Until then, builders must continue to plan for shortages and delays. Certain strategies can limit their exposure to the ongoing material shortages and price volatility, including:
- Incorporating price escalation clauses into their sales contracts. This provides builders with leverage to pass on volatile material price hikes to their customers.
- Preordering lumber and other materials to secure prices and availability. While this can be an effective tactic at locking in prices, builders must also factor storage and insurance fees into their total costs.
- Obtaining price guarantees from suppliers to avoid rising costs. While this strategy may not be deployable by smaller builders with less buying power, obtaining price guarantees from suppliers, even if only for a short time, can help reduce builder risk.
The takeaway
While the 2022 housing market will not see the record growth experienced in 2021, the boom in housing is far from over, and builders must be prepared to capitalize on returns and strike while the iron is hot.
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