HOUSING INDUSTRY OUTLOOK RESIDENTIAL CONSTRUCTION INSUFFICIENT TO EASE HOUSING SHORTAGE

------------ BY JOE K. ELLING

LAGGING THE HISTORICALLY low levels of home building and apartment construction since 2008, housing industry analysts estimate there is a shortage in the stock of housing units ranging from 1.7 million to 3 million. The demand for new housing units equals the sum of household growth, replacement of housing units lost due to disaster or demolition, and vacation homes. Over the last three years, annual household growth in the U.S. averaged roughly 1.3 million. Annual estimates of the other factors driving the demand for new housing units are not available, but the common assumption is that the sum of these factors totals 300,000 per year. Housing starts plus mobile home shipments over the last three years have averaged 1.6 million units, about equal to the demand for new housing units. Therefore, no progress has been made to chip away at the shortage of housing units to start the decade.

Is the Federal Reserve done tightening?

One factor critical to the outlook for residential construction is what one wants to believe about the direction of monetary policy on the part of the Federal Reserve. After 15 years of what must be called nontraditional monetary policy, which contributed to the surge of inflation in the second half of 2021 and continued into 2022, policy makers at the Federal Reserve seem to have the resolve to do what it takes to bring inflation back to 2% on a sustainable basis. The prevailing wisdom seems to be that the 25-basis-point increase in the federal funds rate enacted on May 3 is the last increase and the Fed will start to ease its policy stance sometime in the second half of 2023.

To believe that, one must accept policy makers at the Fed are convinced that inflation is on the path to 2% inflation. However, recent inflation data contradicts that notion. As measured by the GDP deflator, inflation in the last three quarters has run near 4% at a seasonally adjusted annual rate, double the desired target rate of 2%. (See chart below.) Upward pressure on labor costs continues. Hourly wage gains are running at a 4.5% rate, and the Bureau of Labor Statistics estimates labor productivity in the first quarter of 2023 was down 0.9% from the first quarter of 2022. Unless wage gains slow, which is hard to see happening with the unemployment rate at 3.5%, and labor productivity growth improves, then it is unlikely to see inflation coming down to 2% in the next six to nine months. This means the Federal Reserve is unlikely to be in the mode of loosening monetary policy in the second half of 2023.

Affordability challenge persists

The tightening of monetary policy contributed to the surge in the rate on a 30-year fixed-rate mortgage from the 3% range in 2021 and the first quarter of 2022 to 6.5% since the fourth quarter of 2022.

could afford just 38% of the homes sold in the fourth quarter of 2022. This marked a record low for this measure created in 2012 by the NAHB economics group staff.

Homebuilders have been offering incentives, such as mortgage rate buydowns, to generate sales. This is evident in the sales increase in the first quarter of 2023 compared to the fourth quarter of 2022, as shown in the chart above. Compared to the first quarter of 2022, though, sales were still down 14%. Given the high likelihood that the rate on a 30-year fixed-rate mortgage will remain in the 6.5% range through 2023, it appears homebuilders will have to maintain their incentive programs to generate sales.

Record number of apartments under construction

This dramatically reduced the number of potential home buyers that could qualify for a mortgage to purchase a new home and is reflected in the National Association of Home Builders (NAHB) Opportunity Index. The Opportunity Index measures the percentage of homes sold in each quarter of a year that a family earning the median family income could afford under a common set of mortgage qualification rules. As shown in chart below, the Opportunity Index averaged 61% from 2017 to 2020, and since has been on a downward trend due to the rise in the mortgage rate and higher home prices. At the end of 2022, the Opportunity Index was a record low of 38, meaning a family earning the median family income

In 2021 and 2022, multifamily starts averaged 511,000 per year. This marks the highest two-year average for multifamily starts since 1986-87. Multifamily starts in the first quarter of 2023 averaged a seasonally adjusted annual rate of 555,000 units. At the end of March, there were 958,000 multifamily units under construction. (See chart below.) The last time there was this number of multifamily units under construction was November 1973.

Concerns about future rents with so many rental units coming on the market in the next two years, high interest rates and falling building values, the prevailing wisdom is that multifamily starts will be falling over the course of 2023 and into 2024.

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