Most everyone is painfully aware of the slowing of the housing market during the second half of 2018. Declining housing affordability took its toll on consumer motivation to buy a home. Higher construction costs and increased home prices over the last several years, combined with higher interest rates and lackluster income gains, were the primary causes for these declines. According to the National Association of Home Builders (NAHB) and Wells Fargo’s Housing Opportunity Index (HOI), 56% of new and existing home transactions nationwide were affordable for a typical family during the third quarter of 2018.
On the supply-side of the affordability equation, labor shortages, building material price volatility, and land/lot access issues have contributed to the rising costs. But government policy is failing as well, with rising regulatory burdens contributing to severe affordability challenges in many markets. Prior NAHB analysis found that such regulatory burdens increased 29% from 2011 to 2016 alone.
Going forward, NAHB’s Economics team is watching the 10-year Treasury interest rate closely. That rate effectively determines mortgage interest rates. The key challenge for the housing market is to manage construction costs as the cost of homeownership rises. The expectation is that mortgage rates will continue to rise alongside long-run trends for the 10-year rate, given a tight labor market and the Fed’s intended policy to continue to tighten monetary policy.
NAHB expects the Federal Reserve to raise the short-term fed funds rate just two times in 2019. Doing so, will slow the economy and, to a lesser degree, continue to raise mortgage interest rates. We expect those rates to rise above 5.2% by the end of the year. This will further reduce resale and new home sales demand. However, rates fell significantly in December, which should provide some momentum for the housing market as we start 2019.
Furthermore, the housing market will benefit from favorable demographic tailwinds, including the Millennials moving from rentership to homeownership. In fact, due to this aging, the U.S. has seen nine straight quarters of fairly robust growth of demand on the ownership side of the housing market. A near 50-year low for the unemployment rate supports demand for both rental and for-sale housing.
However, higher mortgage rates have had stronger than expected impacts on housing demand last year. This was clearly reflected in the December edition of the NAHB/Wells Fargo Housing Market Index, which dropped to a level of 56 – still positive, but it was the lowest reading in three and half years. Unless income growth accelerates markedly, housing affordability can be expected to decline further in 2019.
In addition to interest rate risk, trade policy is a concern. Tariffs on Canadian softwood lumber produced a large amount of price volatility in 2018. During the summer of 2018, higher lumber costs were adding $8,000 per new single-family home. Additional tariffs on steel, aluminum, and other Chinese goods could increase total development costs by $1 billion or more dollars in 2019, offsetting some of the benefits of the 2017 tax cuts. Moreover, higher costs produced by tariffs represent an inflation risk, thus adding pressure to increase interest rates and slow the overall economy. A new US-Canadian softwood lumber agreement is needed, and broader trade issues need to be resolved quickly to allow the economy to grow.
NAHB’s forecast calls for slight to flat growth for single-family construction, as higher interest rates weigh on housing demand. Multifamily construction should level off at above normal levels of production, as the for-sale market weakens. Townhouse construction is set to exceed the growth rates for single-family construction and apartment building, as this submarket provides an effective way to add entry-level housing, where inventory is needed most. Overall, we expect total housing starts to come under 1.3 million, with single-family starts remaining below levels seen between 1992 and 2007.
A decline in housing affordability suggests the reduced level of growth for home construction will be widespread. That said, within metropolitan areas, we expect inner suburbs to perform well in an otherwise challenging year. Most single-family construction will be concentrated in the West and the South, with Mountain area markets showing signs of good expansion due to lower development costs.
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