Sprinting era in America, which is just around the corner, brings many good traditions. Crack the bat on baseball diamonds. Children rolling Easter eggs on the White House lawn. Families selling dusty old furniture in yard sales. There is, however, one ritual that stands above all others in its financial importance: the spring selling season, when the housing market comes to life – or, on rare occasions, fails to do so . This is perhaps the single biggest confirmation of the global economic outlook for the rest of this year, with recession at one end of the spectrum and worst-case scenario at the other.
The importance of American housing is not so great in its absolute size, although it is about $45trn in total value. Rather, it is a bellwether of the economy’s performance amid rising interest rates. Has the Federal Reserve hiked rates enough to calm inflation without squeezing growth? Has it gone too far? Or, perhaps, not long enough? As one of the earliest and largest sectors to respond to changes, the property market offers answers.
Until last month, the evidence seemed clear. Even before the Fed started raising its policy rate, mortgage lenders, who were anticipating a tightening of the bank, had started spending more. From 3% at the end of 2021, the rate on 30-year fixed mortgages exceeded 7% by October, the highest rate in more than two decades. Lo and behold, the action quickly took off. Customers stayed on the sidelines. Builders suspended new construction projects. Dealers had cut prices. So far, so predictable.
But recently, signs of an early and largely unexpected rebound have emerged, raising concerns that higher rates are not having the desired effect. New home sales in January jumped to a ten-month high. Surveys measuring the confidence of both homebuilders and homebuyers have improved. American property companies have reported more visitors to their show homes. “We’ve seen the trend pick up week after week,” said Sheryl Palmer, chief executive of Taylor Morrison, one of the country’s largest homebuilders.
The case for optimism is that the American real estate market has found a floor. Buyers are returning but not the frenzy from the covid era. A good spring season could, in theory, allow house prices to stabilize and builders to resume construction, increasing growth without keeping up with inflation. The case for pessimism rests on the idea that the interaction between the housing market and inflationary trends is too powerful to ignore: if buyers return to a supply-constrained housing market, price increases will follow. And if the Fed sees that a sector as sensitive to rates as property does not respond to tighter monetary policy, it may judge that it needs to be more hawkish. Unfortunately for America, and the world, the desperate case seems more realistic.
Analysts point to a range of factors behind the rebound. After a year of brisk sales, there is pent-up demand. Wealthier buyers, paying in cash, represent a larger share of the market. Buyers may also be getting used to higher rates: some saw good when mortgage rates fell from north of 7% late last year to 6% in January.
Perhaps most importantly, developers have designed a menu of incentives. There is nothing unusual about using discounts when the market falters; the modern element, this time, has been the aggressive use of mortgage purchases through insider lenders, actually paying some interest on behalf of buyers to lower mortgage rates. This has allowed developers to offer mortgages that appear to be from the pre-inflation era of the 2010s. Pulte, a homebuilder, has 30-year fixed rates at just 4.25% on some of its nearly completed properties. Toll Brothers, another builder, offers 4.99%. “We learned so much last year about how to deal with consumer concerns,” Ms Palmer said.
This is a great piece of financial engineering. John Burns, a property consultant, estimates that paying 6% of a mortgage upfront, and getting lower rates for the life of the mortgage, works out as a saving big for buyers by cutting home prices by 16% but leaving them with higher rates.
The obvious question is whether such concessions are sustainable. There are two potential obstacles. Homebuyers would find it difficult to resell their homes at the same price as buyers who did not benefit from a buy-to-let mortgage. As a result, Mr. Burns believes appraisers could cut appraised home values, which would force sellers to lower prices. Second, buying down goes against what the Fed has been trying to do: curb real estate purchases to bring demand and supply into better balance.
Last year Jerome Powell, the chairman of the Fed, spoke of the need for “a bit of a reset” in the real estate market. In terms of affordability, this reset has longer to run. Mortgage payments on new homes now reach nearly 30% of the average household income in America, almost double their average in the 2010s. Rising incomes, a decline in mortgage rates or a decline in house prices would bring affordability back to pre-covid levels. All three have started to happen, but there is a long way to go. Nationally, home prices have fallen just 4% from their peak in mid-2022, barely eating into their 45% rise during the pandemic, according to the s&p CoreLogic Case Shiller Index.
There is also a more elusive part to the equation: housing supply. Homeowners who have locked in low rates are ready to move. There are just 1.1m homes on the market for resale, half the average since the late 1980s. Meanwhile, housebuilders are more cautious than they were two decades ago during the global financial crisis. When the covid buying mania got going, house building went up but didn’t, because developers saw the increase as insignificant. Then, when the market grew, they almost stopped their activity.
This is good for builders’ balance sheets, leaving them with a thin cash position. But it’s bad news for everyone. Investment in residential construction fell by a fifth in real terms last year. It is likely to fall further this year. Surprisingly, despite the increase in demand, new starts have fallen so far. Dhaval Joshi from bca Research notes that declines of similar magnitude in housing investment have almost never occurred in the past. Robert Dietz of the National Association of Home Builders has this concern: “You’ve never had a period where there was a decline in prices and a significant decline in residential investment, and you didn’t have a recession.”
This goes against the hope in financial markets that America can stay away from recession, and against the hope in the real estate market that the worst is already behind it. Companies, economists and investors have learned to be wary of inflation over the past two years: short-term bouts of declining inflation that give way to a reassertion of price pressures . The housing recovery may also be a headwind, with the sector on a weaker footing than it appears and the Fed forced to keep rates higher for longer. A lot is riding on the spring sales season. ■
Photo: Timo Lenzen
