The long-awaited slowdown in the housing market may finally be upon us, but maybe not. We might just be witnessing a reset in expectations that provides the foundation for continued vibrancy. There are no doubting several important data points which have turned negative in recent months, and these data points primarily relate to the speed of existing home sales and new home sales (home prices continue to move higher, but at a decelerating rate of growth). Any casual observer of the homebuilding industry need to look no further than publicly traded homebuilders' stock prices to get a sense of the desperation that has enveloped this industry over the past year. Homebuilders at their core are manufacturers and like other manufacturing industries, have suffered in recent quarters from rising input costs (land, materials, labor), supply chain woes and deteriorating margins. The Evercore ISI Homebuilders Survey has fallen nineteen of the last twenty-three weeks after hitting its high for the year in March. The survey notes that aside from mortgage rates, stock market declines and overall economic uncertainty, builders are seeing less urgency on the part of buyers to transact as they await a dip in prices.[1]
The notion of a “housing recession” began to dominate headlines several weeks ago with the release of builder confidence numbers (NAHB) which fell in July for the eighth straight month and monthly home sales data (NAR) which declined for a sixth straight month in July. The contraction in builder confidence and sales activity led industry leaders to declare a housing recession, though they do take pains to note that this is not meant to imply a recession in home prices or a pending housing depression which triggered the global financial crisis I(GFC) in 2008. Supply and demand imbalances in the housing market are supportive of home prices and even with higher interest rates and lower overall affordability for homeownership, supply remains tight and consumers are looking to buy homes.[2]
While some may try and draw parallels between now and 2008’s housing crisis, the differences far outweigh the similarities with one of the main distinctions being the health of owner households and the strength of the job market. Home inventory levels have ticked up a bit in recent months but remain at low levels. A recent article by Housing Wire references that home sale listings are currently below 1.0 million, after bottoming in the 800k range, but substantially below the normalized level of 2.0-2.5 million.[3] One relevant corollary to the 2008 crisis is that the U.S. housing market never experienced the rebound in supply that was needed to meet the eventual rebound in demand. The resulting housing deficit exacerbated the sharp acceleration in home values associated with the post-pandemic home purchase binge. As the country slowly reopened in 2021 and the population adjusted to life in the aftermath of a global pandemic, a herd mentality took hold within the housing market and FOMO (fear of missing out) drove households to pay up for the privilege of homeownership to an extend never quite seen before. This phenomenon has been compounded by an unprecedented level of mobility for the U.S. workforce as hybrid work and work-from-home became more common place.
The pullback in new home sales and existing home sales reported for July, down nearly 30% and 19%, respectively from the prior year, is a direct manifestation of the evolving dynamics in the housing market following the pandemic. We believe that this “pause” in transaction activity on the part of households represents a reset and period of price discovery for buyers as they assess risks to the broader economic environment and the high level of price appreciation which has occurred over the past 12-18 months. It is important to note that while home values have largely moved higher over the past several months, we have seen a deceleration in the growth rate. A recent Redfin analysis of multiple listing data (MLS) shows that year over year home price appreciation was largely in the 5-8% range from 2014-2020, and jumped to a peak of over 25% in July of 2021. The growth rate for July of 2022 was 7.7%, right in line with the five-year period leading up to the pandemic.[4]
We strongly believe that the underpinnings of the housing market remain solid. The historic uptick in home price appreciation over the past 12 months has begun to moderate as a result of rising interest rates, rising inflation and the expectation that while jobs and wages remain quite strong, they could backtrack as U.S. economic growth slows and possibly transitions into a mild recession for several quarters. With the economy at an inflection point, it is not surprising to see a widening of spreads (difference between asking and offering prices) between buyers and sellers of homes with sellers trying to extrapolate ever higher prices based on the recent past, while buyers are pushing back and discounting existing prices in light of the potential for weaker conditions in the future. In fact, a very similar exercise is also unfolding across the residential rental market where transaction activity has come to a temporary pause as well with buyers and sellers reassessing future valuations. True to form, the underlying fundamentals for rental housing have also been remarkably strong over the past year for most of the same reasons as for-sale housing. Rent growth for rental housing and residential REITs will moderate in coming quarters as current levels of growth are unsustainable and unhealthy for the long-term wellbeing of both tenants and landlords.
As we move towards the final quarter of 2022, it is possible that negative rhetoric on the housing market could intensify and we would caution residential REIT investors to look beyond the housing headlines and realize that strong fundamentals including occupancy levels, rent growth, high resident retention rates, operating expense management and reasonable rent-to-income levels will all contribute to a constructive outlook for 2023.
Footnotes:
[1] Evercore ISI: Homebuilders Survey, August 23, 2022
[2] Mortgage News: Signs of Change Afoot In Housing Market; Jon Reed (August 2022)
[3] Housing Wire: Are We In A Recession (August 2022)
[4] RedFin News: July Home Sales Dropped %…..; By Dana Anderson (August 22, 2022)
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