Is Housing the Next Shoe to Drop for the Economy?

The confidence of homebuilders fell 12 points in July in its sharpest drop since the early days of the coronavirus, the National Association of Homebuilders reported on Monday.

The organization’s monthly index dropped to 55 from 67 in June and is now at its lowest level since May 2020.

“Production bottlenecks, rising home building costs and high inflation are causing many builders to halt construction because the cost of land, construction and financing exceeds the market value of the home,” said association Chairman Jerry Konter, a home builder and developer from Savannah, Georgia. “In another sign of a softening market, 13% of builders in the HMI survey reported reducing home prices in the past month to bolster sales and/or limit cancellations.”

The organization’s chief economist, Robert Dietz, noted that affordability remains a critical issue for would-be buyers.

“Affordability is the greatest challenge facing the housing market,” Dietz said. “Significant segments of the home buying population are priced out of the market. Policymakers must address supply-side issues to help builders produce more affordable housing.”

All three of the index’s components posted declines for the month, with the current sales conditions falling 12 points to 64, future sales expectations declining 11 points to 50 and traffic of prospective buyers also dropping by 11 points to 37.

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No part of the U.S. economy fared as well as housing these past two years as the coronavirus wrecked many sectors from automobiles to hospitality.

The median price of a single-family home jumped 30% since the pandemic began, or $100,000. Mortgage rates at the end of 2020 were 2.68%. Employment in the construction industry went from 6.5 million in April 2020 to 7.7 million last month.

But that all is changing. While prices rose 20.4% annually in April, the most recent month for which data is available, that was down slightly from 20.6% in March. Mortgage rates, meanwhile, have soared to around 6%, although there has been a slight let-up of late.

Along with having a job, owning a house is a measure of many people’s overall financial health. Over time, owning a home has provided a solid foundation for a middle class lifestyle.

The pandemic accelerated all of that. Locked in during the pandemic, many Americans either expanded their existing homes, raising their values, or used the increasing equity to trade up to something bigger and better. Remote working allowed homeowners to move further out, enabling them to purchase larger properties. Sun Belt locales such as Phoenix and Tampa, Florida, became housing hot spots while the big urban centers of New York and San Francisco saw their allure fade.

That is now changing, and exactly what effect a slowdown in housing will have on the overall economy will become clearer this week as the economy awaits reports on housing sales, prices, new home starts and building permits. There could be a momentary bounce in some of the data as increasing inventories of homes for sale brings the supply/demand balance into a more normal equilibrium.

The backdrop for housing, as it is for the overall economy, is the Federal Reserve’s current policy of raising interest rates to combat surging inflation. As rates have risen, that has made buying a house that much more expensive. The specter of rising unemployment and a recession also loom as threats to the economy. Consumer sentiment, meanwhile, is down 32% from a year ago.

On Tuesday, the economy will get a look at housing starts and permits for June, with expectations of a slight uptick in the former to an annual rate of 1.58 million from 1.55 million in May, and a slight downward move in permits to 1.65 million from 1.7 million a month earlier.

Wednesday brings a report on existing home sales for June, with the consensus forecast of 5.37 million annualized, down from 5.41 million in May.

Altogether, the reports should reflect a housing market that is cooling from its red-hot pace of 2021, but not yet rolling over.

“Broadly speaking, the housing market has operated in a challenging environment through the first half of the year,” said Sam Bullard, managing director and senior economist at Wells Fargo Corporate & Investment Banking group.

“Home builder confidence has been in a free-fall since January, reflecting the impact of rising mortgage rates,” Bullard added. “Conversely, we look for housing starts to rebound modestly in June following the sharp 14.4% drop registered in May. Building permits have declined for two months in a row, yet we do expect some reversal in starts activity given the severity of May’s decline.”

“As the Fed continues to raise interest rates in coming months to combat soaring inflation, headwinds to the housing market will persist which should result in weaker housing activity for the foreseeable future,” Bullard said.