In June 2021, I wrote a post here titled “3 Reasons Why the Real Estate Boom Isn’t a Bubble”. At the time, a persistent housing shortage drove up home prices, but the combination of low rates, healthy savings, and high income still made it quite affordable to buy a home. The Federal Reserve Bank of Atlanta agrees: According to a recent article, affordability was quite high when the article was published. But oh my, how times have changed.
The affordability index suddenly fell from those good times to its lowest value since before the financial crisis. According to the Atlanta Fed, the decline was (and is) mainly caused by higher prices and much more expensive mortgages. These factors also affect homeowners who have bought or refinanced their homes at historically low rates in recent years: they are stuck, as moving to a new home in many cases entails much higher mortgage payments. This in turn contributes to the shortage of existing owner-occupied homes.
Both existing and new home sales fell. Data from the National Association of Realtors shows existing home sales fell from a peak of 6.5 million units a year in early 2022 to about 4.1 million units, or about the same as during the worst point of the pandemic, and that they go lower. It is similar to the drop in new-build home sales, which in July 2022 reached the lowest level since March 2016.
Conditions are unlikely to change much, as mortgage rates will remain high as long as the Fed remains determined to keep rates high to fight inflation. This means sales will slow even further unless a price adjustment occurs. This has affected the construction industry, which had ramped up production in response to higher prices, but is now finding it more difficult to sell their new build homes.
Making matters worse for homebuilders is that according to data from the Atlanta Fed, there’s a lot more under construction, adding to the pipeline of new homes hitting the market.
The growing housing surplus is confirmed by other measures, such as the number of housing units in the US as a percentage of the population. That rate peaked during the construction frenzy fueled by the housing bubble of the mid-2000s, which took several years to adjust. But as prices recovered and sales boomed, new construction picked up and drove that percentage even higher.
And this brings me back to the point I made earlier: with lots of new inventory, even more coming out, and affordability at an all-time low, home prices will have to adjust or sales will continue to fall. This may not necessarily be a serious problem for existing homeowners who can wait, but a major problem for builders who, because they have capital in stock, must offer discounts to move their product. But because of higher construction costs due to the supply chain crisis, their margins have shrunk and their ability to lower prices and still make a profit may be limited.
Either way, this isn’t entirely unwelcome news for the Fed, which aims to lower prices, slow down the economy, or preferably both. A slowdown in construction activity and lower house prices would greatly contribute to achieving the intended results. The first part is unfolding, as the number of permits for new-build homes is 29% below the recent peak. Notably, permits fell between 30% and 77% from a previous peak in 7 of the last 8 recessions, suggesting that the slowdown in construction spending could get worse if the recession everyone is expecting actually materializes.
When local factors are taken into account, national trends matter less
It is important to bear in mind that there are differences between the total property numbers presented above and the reality on the ground, which are much more influenced by local conditions than national figures.
Take, for example, three Florida counties (Manatee, Sarasota, and Charlotte) just south of Tampa, on the Gulf of Mexico—where I happen to live and work.
According to Realtor MLS data, the number of real estate listings here declined fairly steadily from about 28,000 active listings in the months leading up to the 2008 financial crisis (when monthly sales were a paltry 1,100 units per month) to a low of just 2,000 active listings in March 2022 (shortly after sales hit a red-hot volume of 4,000 units per month, depleting stock). In recent months, the number of active ads has recovered slightly and once again exceeded monthly sales, but the number of units for sale is still much lower than for most of the past 15 years.
Real estate transactions in this area are impacted by tourism, retirement, and a migration to Florida from other states that gained momentum with the trend toward remote work. In addition, the area attracts buyers of luxury homes who are less sensitive to price increases and less dependent on mortgages.
The point is that hyperlocal conditions are outpacing national numbers, so while the information I presented earlier is important for investors considering real estate investments through tools such as VNQ