July 19, 2022

Rising rates biting the construction industry

Rising mortgage rates, record home prices, and the high cost of building materials are biting the construction industry.

New construction rose to a 16-year high in February before backsliding. Overall, single-family permits declined in the first five months of 2022, down 2% from the same period in 2021. At the current rate, 1.72 million homes would be completed in the next 12 months.

Single-family houses accounted for about 64% of new construction in April, well below historic averages. Starts fell 7.3% to an annual rate of 1.1 million.

Housing represents about a third of the value of the basket of goods and services the Bureau of Labor Statistics (BLS) uses to track inflation in the Consumer Price Index (CPI).

According to the BLS, housing costs have contributed only 4% of increasing inflation in 2022 but could be the canary in the coal mine on how the entire economy will react amid rising interest rates.

The CPI measures price growth for the same goods and services over time, so the BLS adjusts for changes in quality of the properties it observes. Changes in the cost of housing (called “shelter” by BLS) come from surveying a cross-section of about 50,000 rental homes, with one-sixth of these changed out every year for diversity.

The value of owner-occupied homes is determined using the average rents paid for comparable rental housing in the same area. This can be problematic for several reasons.

Normally, house prices and rental prices are determined by supply and demand factors that do not always move in tandem. For example, if demand for homeownership rises because mortgage rates fall, house prices will rise but rents will not. If home construction costs increase, on the other hand, the price of both rental and owner-occupied housing rise.

However, the tightening of the housing market during the pandemic led to a vast divergence between real housing market prices and CPI measures. A great deal of the increase in prices among owner-occupied housing appeared in the suburbs and exurbs, where there are typically fewer rentals to compare.

Given current trends, analysts anticipate rent inflation will increase by about 7% in 2022 and 2023, almost twice the pre-pandemic five-year average.

With mortgage rates surging and home prices sky-high, affordability has deteriorated considerably. It would be reasonable to expect softening in housing demand.

But as spring turned to summer, the number of active home sellers swelled. June home listings were up 6% year over year after two-plus years of abnormal seasonality.

Active listings are still 60% below the level of March 2020, just before the onset of the coronavirus pandemic. But if trends continue, it could tip market conditions in a buyer-friendly direction.

Already, more home sellers are dropping their asking prices as competition eases. Many of these are in hotter pandemic markets where ultra-high prices are no longer sustainable, including Boise, ID, Denver, Salt Lake City and Portland, OR. Nationwide, homes with price reductions jumped to 10.5% in May, compared with 6.2% last year.