US RESIDENTIAL HOUSINGPROFILE AND OUTLOOK
September 11, 2023
When Abraham Lincoln said, “The strength of a nation lies in the homes of its people,” he conveyed an accepted belief that our housing supply and ownership are key elements of the social vibrancy of our nation. Moreover, housing is also a crucial component of our nation’s economic growth and of household financial security. With the value of the US housing stock estimated at $45.3 trillion in 2022, this sum represents 32.4% of total household wealth and 17.7% of US gross domestic product (GDP).
However, several factors, such as spiraling home prices and rising mortgage rates, have begun to affect the financial outlook for the housing sector. One measure of its viability—the Goldman Sachs Housing Affordability Index—is shown below. This index measures how well a typical household can afford the monthly mortgage payments for a median-priced home, using current mortgage rates, property taxes, and insurance costs after a 20% down payment.
An index value of 100 means that a household earning the median income in the US ($81,454 as of 6/30/23) has enough income to qualify for a mortgage on a median-priced home ($410,200 as of 6/30/23). An index above 100 signifies that households earning the median income have more than enough income to qualify. Unfortunately, after peaking at 134 in 2020, the index has fallen to a level of just 71 in August 2023. This means that 29% of households earning the US median income are becoming priced out of the housing market.
In this report, The Mather Group LLC (TMG) reviews the current state of the residential housing market and several key factors shaping its outlook. These factors include inventory trends, mortgage availability, land costs, and construction outlays. It appears that the trends for each of these factors may suggest continued stress in the housing market.
Inventory Trends
The US housing supply consists of existing and new homes. Existing homes may or may not be for sale, while new homes are intended for sale, whether still under construction or recently completed. The current dynamics of the housing sector suggest that housing demand now exceeds supply.
Let’s begin by examining the level of existing homes for sale. As shown in the graphic below, nationwide inventory peaked at 3.8 million homes in 2007, followed shortly by the Global Financial Crisis (GFC). The GFC had many sources, but speculation and poor underwriting in the real estate sector were strong contributors.
In the following years, this excess inventory fell precipitously and, since 2022, has hovered around 1 million homes. Historically, this inventory level had been around 2 million homes, so there is a definite shortfall in current availability. The fact that many existing homeowners have mortgage rates of 3% or less has also deterred some from offering their homes for sale, again limiting inventory.
The profile of new home supply is like that of existing homes. As shown in the graphic below, there was significant speculation in the construction of new homes leading up to the GFC, with a precipitous fall afterward as builders and potential buyers encountered extreme financial stress. 2012 marked the nadir in new home construction, which is only now returning to its 40-year average.
However, the median price of new homes sold barely fell in the aftermath of the GFC, and its subsequent rise has far outstripped the growth in new homes available for sale. In true economic fashion, when demand clearly exceeds supply, the upward pricing of any product (new homes in this instance) will become the mechanism to bring it into balance. Little relief from this price rise appears imminent.
Mortgage Availability
Of the many elements driving the Housing Affordability Index, the interest cost of a 30-year fixed-rate mortgage (the most common mortgage type) dwarfs the others. Since housing demand exceeds the current supply, this imbalance has had a negligible effect on mortgage rates. Instead, it has been the recent reversal of the Federal Reserve Board’s (Fed) artificially low interest rates (intended to throttle the upsurge of inflation) that has been the primary driver of rising mortgage rates.
As shown in the graphic below, the 30-year mortgage rate is significantly linked to the 10-year US Treasury bond rate. With the Fed having raised rates 11 times since March 2022—from near zero to a range of 5.25%-5.50%—the 10-year bond has risen in lockstep to its current level of 4.1%. Although the historic difference between mortgage and Treasury bond rates had been 1.7% since the GFC, it is now 3.0%.
This recent doubling in the spread between mortgage and Treasury bond rates is the result of a significant decrease in mortgage availability due to two factors. First, the March 2023 collapse of several regional banks (e.g., Silicon Valley Bank) has caused many banks to reduce their mortgage offerings to preserve capital and liquidity at the direct request of bank regulators such as the Comptroller of the Currency.
Second, three of the largest mortgage providers—Bank of America (ranked tenth in 2022), JPMorgan Chase (ranked fifth), and Wells Fargo (ranked third)—have almost completely exited the mortgage market due to poor returns. Using Q4 2022 for year-over-year comparison with Q4 2021, Bank of America originated 77% fewer mortgages by dollar volume; JPMorgan Chase’s originations dropped by 84%; and Wells Fargo’s originations fell by 70%.
It is unlikely that either of these two factors will be reversed soon. Hence, there may be little opportunity for mortgage rates to fall significantly and lift the Housing Affordability Index to more favorable levels for would-be homeowners.
Land Costs
The first financial step for any homebuilder is to acquire land on which to begin construction. As shown in the graphic below, while the median lot price for a single-family home in the US was $55,000 in 2021, there are significant differences in pricing due to regional factors. For example, the median lot price in New England was $200,000, while it was just $42,000 in South Atlantic states such as Florida and Georgia.
Several factors underlie these regional pricing differences. For example, in states such as Arizona, Florida, and Texas, the amount of rural, undeveloped land is far more extensive than in more densely populated states such as California, Connecticut, and Massachusetts. Another factor is the stringency of local zoning and regulatory laws, which often differ widely. These include such restrictions as minimum lot size, landscaping requirements, lighting levels, environmental risks, and a requirement for off-street parking.
However, the ease with which homebuilders have been able to build significant levels of new homes in some states may appear to be ending due to one factor no builder can control: the availability of water. For example, in Phoenix (the fifth-largest city in the US), the state government will no longer approve new housing development in its suburbs that rely upon the use of groundwater. Only builders who can utilize existing surface water or recycled water will be approved for further development. So, potential homebuyers may have to add water access as another factor affecting the Housing Affordability Index.
Construction Outlays
Prospective new home buyers may remember the supply chain shortages that both reduced the supply and increased the price of building materials, starting in January 2021. As shown in the graphic below, plywood prices doubled between January and June 2022. 94% of new homes were framed in wood in 2022, but lumber cost is estimated to compose only 4% of a new home’s selling price. Plywood prices then started to fall, and prices are now just 15% above their July 2018 price level.
More importantly, it is estimated that construction labor costs represent 40%-50% of a new home’s selling price. The recent labor shortage experienced across all industries has not escaped the home building sector. Partly due to Covid fears, sizeable household stimulus payments, and strong labor demand in other, less arduous industries, the home building sector has experienced a worker shortfall.
As a result, the increase in average hourly earnings for construction workers has risen by 23% during the same 5-year period from 2018 onward, well above the rise in pricing for plywood and other building materials. Despite these rising wage levels, there remains a shortage of construction workers in the homebuilding industry. This shortage is resulting in a constraint on the supply of new homes due to increased labor costs, project delays, and decreased work quality.
It is doubtful that such wage growth will decelerate significantly in the near term. Thus, the Housing Affordability Index may remain challenging for many new home buyers until such cost increases begin to abate meaningfully.
In conclusion, the factors analyzed in this US Residential Housing Profile and Outlook suggest that the availability and pricing of both existing and new homes will remain strained in the near future. If the Fed’s interest-rate strategy to reduce inflation is successful without invoking a recession, then current mortgage rates and housing costs may retreat to more affordable levels. The Housing Affordability Index could then begin rising to a level near 100, allowing more households to enter the housing market.
TMG continues to employ its risk management tools in consideration of recent market and inflationary volatility. Clients who adhere to their financial plan maintain the strongest pathway through this potentially volatile period. Your trusted advisor at TMG is ready to respond to any questions or concerns you might have, and to help ensure that your financial plan remains both timely and actionable. Please reach out to your advisor for guidance at any time.
Sources: Arizona Department of Water Resources; Bloomberg; Bureau of Economic Analysis; Bureau of Labor Statistics; Census Bureau; Department of Housing and Urban Development; Federal Home Loan Mortgage Corporation; Federal Reserve Bank of St. Louis; Federal Reserve Board; Fortune; Goldman Sachs Global Investment Research; Lincoln Institute; National Association of Homebuilders; National Association of Realtors; Office of the Comptroller of the Currency; Redfin; US Treasury; Wall Street Journal
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