The Real Estate Market experienced a surprising surge in new housing starts in May, as reported by home builders. The annualized housing starts reached 1.63 million, marking a significant 21% increase compared to the previous month.
This substantial rise in housing starts in May indicates that home builders and apartment developers are increasingly optimistic about a recovery in the US Housing Market in 2023. The stock market has also reflected this bullish sentiment, with investors showing keen interest in homebuilder stocks and driving their prices to record highs.
However, there are concerns regarding the sustainability of this optimism. Builders are increasing production despite a 35% decrease in traffic at their homebuilding sites compared to pre-pandemic levels. Additionally, economic indicators forecast a worsening recession in 2023 as Jerome Powell and the Federal Reserve continue to maintain elevated interest and mortgage rates.
The decision to ramp up housing starts may have negative consequences for builders but could benefit homebuyers and renters. In this analysis, we will delve into the data on the recent surge in housing starts, and its impact on home builder stock prices and provide insights into the market’s potential trajectory for the remainder of 2023 and beyond.
Notably, the report from the US Census Bureau revealed a surprising 19% spike in single-family home construction. On an annualized basis, 997,000 single-family homes were initiated, reversing the downward trend observed in the past year since the Federal Reserve initiated interest rate hikes. This increase in housing starts is encouraging for prospective single-family homebuyers, who can anticipate more new homes entering the market in the coming months.
Another surprise in the report is the heightened activity of apartment developers and new housing starts in May 2023. They commenced the construction of 624,000 multifamily and condo units, reflecting a 28% increase from the previous month. This level of construction sets a record dating back to 1997.
This surge in apartment construction further indicates the continuation of the rental market’s slow decline in America. Data from Apartment List reveals a significant increase in apartment vacancy rates, reaching 7% over the past year. With the additional construction, rental vacancy rates are expected to rise further, exerting downward pressure on rents and potentially impacting home prices as well.
In total, the cumulative effect of these new housing starts in May will contribute to the already considerable backlog of construction. Currently, there are 1.1 million apartment units and 840,000 single-family homes under construction. The combined total of 2.0 million units in construction or permitting represents the highest level on record.
The soaring stock prices of home builder companies reflect the surge in housing starts and several months of increasing new home sales. For instance, DR Horton, the largest builder in America, has witnessed a remarkable 93% increase in stock price over the past year and a staggering 191% increase over the past five years. Their stock is currently trading at an all-time high, surpassing the peak witnessed during the pandemic in late 2021.
However, it is important to recognize that this rally in homebuilder stock prices could be indicative of a potential bubble driven by unfounded optimistic sentiment. Although new home sales have increased over the past few months to an annualized rate of 683,000, this figure remains approximately 35% below the peak observed during the pandemic. Moreover, it is comparable to the levels preceding the pandemic in 2018-19. Sustained growth in new home sales for the rest of 2023 and beyond is essential for justifying the surge in homebuilder stock prices.
The allure of 5% mortgage rates and significant price cuts has played a role in driving homebuyer demand. Home builders have demonstrated flexibility during this housing downturn by slashing prices and offering below-market fixed-rate mortgages, such as DR Horton’s 5.5% rate in an environment where market rates hover around 7.0%. These incentives have appealed to homebuyers in 2023, especially considering the historical lows in inventory available for resale. However, these incentives come at the cost of lower profit margins, as evidenced by DR Horton reporting a substantial 35% year-on-year decline in operating income during the first three months of 2023.
This prompts the question of how long builders can continue reducing prices and offering below-market mortgage rates. Prolonged implementation of such strategies will further erode their profits, potentially leading to investor concerns, particularly if homebuyer traffic at building sites continues to remain low.
Homebuyer traffic at builder sites serves as a crucial metric for gauging the future health of builders and the housing market as a whole. The National Association of Home Builders reports this index monthly, and while there has been a solid rebound from the lows experienced in late 2022, the overall level of buyer traffic remains historically low, with an index level of 37. This figure represents a decline of more than 50% from the peak during the pandemic and approximately 35% compared to the “normal times” of 2018-19 before the pandemic.
Thus, there is a disparity between the buyer traffic figures and home builder stock prices, and new housing starts in May. The latter indicators suggest a significant recovery, while the former indicates a recovery but with persisting challenges. While some may dismiss the buyer traffic survey as an outlier due to the prevalent optimistic sentiment surrounding builders in recent months, it aligns with the broader housing market’s situation.
The broader housing market still faces challenges, as reflected by historically low rates of mortgage applications for home purchases. In the most recent week, mortgage applications registered an index level of 165, indicating a 31% year-on-year decrease and a decline of over 50% from the peak during the pandemic. These figures represent a 25 to 30-year low and are consistent with the findings of the Homebuilder Traffic survey. The limited affordability for homebuyers remains a significant obstacle, with home prices relative to incomes and mortgage payments relative to income at their worst levels on record. For instance, in California, the typical household needs to allocate 62% of their gross income to mortgage payments, taxes, and insurance to afford a house in the 2023 housing market—a level near the highest in the last two decades.
As long as affordability metrics remain poor, a genuine and sustained recovery in homebuyer demand is unlikely.
Looking ahead, home builders have thus far managed to navigate this housing downturn by reducing prices and offering discounted mortgage rates. Their success in these strategies has led to increased home construction, which some interpret as a clear sign of a housing market recovery. However, underlying data suggests that a true recovery is still far off, with buyer traffic, mortgage applications, and housing affordability metrics all pointing to an unjustified rally in the current market.
To ascertain the market’s direction, new housing starts in May 2023 are not dispositive. It is crucial to monitor incoming data on housing starts and new home sales in the upcoming months. Subscribing to the Reventure App Newsletter will ensure receiving timely updates on these developments.
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