The Fed's rate cutting cycle should help lower mortgage rates over time, but it is more impactful for short rates.
Housing inventories remain near record lows, yet builders are not increasing construction volumes enough to sufficiently meet demand. Why aren't builders ramping up activity? Several factors are keeping housing supply limited:
- Chronic underbuilding post-2008: Following the housing crisis of 2008, the U.S. experienced a period of chronic home underbuilding. The number of residential construction firms fell from 98,067 in 2007 to 48,557 in 2012, representing a 50% decline. It took a while for the industry to recover, with single-family housing starts finally returning to pre-GFC levels in 2020.
- Elevated mortgage rates: The housing market cratered in late 2022 due to the Fed's rate hikes, resulting in a 16% y/y drop in existing home sales. Although sales are now slightly below long-term average levels, elevated mortgage rates and home prices continue to dampen sentiment. In October, the housing market index increased by 2pts to 43, yet it remains below the neutral mark of 50. The Fed's rate cutting cycle should help lower mortgage rates over time, but it is more impactful for short rates. Long rates, which inform 30-year fixed mortgage rates, typically move according to growth and inflation levels, so these may take longer to decline.
- High costs for builders and homeowners: Since the pandemic, a tornado of factors has pushed up costs for homebuilders and homeowners. These include higher material costs, zoning laws and labor shortages, which have led to higher home prices as well as maintenance and insurance costs for buyers. Inputs for residential construction, as measured by the PPI, rose 14.6% y/y in 2021 and 15.0% in 2022. Although prices grew more moderately in 2023, the rapid increase after the pandemic has made building homes less affordable. The construction industry also faces persistent labor shortages. Total job openings have fallen by 14% over the past year, but construction job openings have declined by only 4%. Due to these factors, home prices are up 30% and are 20% more expensive to insure since 2020. At the national level, builders are still hesitant to invest in new units due to concerns there aren’t enough buyers that can afford them.
Despite these challenges, there is potential for improvement. In fact, building activity has already increased significantly in some cities, particularly along the Sunbelt. For other areas, lower rates should spur more housing demand, which could boost builder confidence to increase construction volumes. Additionally, zoning reform efforts are taking place in more than 100 municipalities across the U.S., which could help reduce costs for builders1. While it will take time for supply to meet demand, the recent improvement in homebuilding activity is expected to continue.