Sspring time in america, which is just around the corner, brings many good traditions. The crack of the bat on the baseball fields. Children rolling Easter eggs on the White House lawn. Families pulling out old, dusty furniture at garage sales. However, there is one ritual that stands out above all others for its great financial importance: the spring selling season, when the real estate market comes to life or, on rare occasions, does not. It may be the most important determinant of the global economic outlook for the rest of this year, with a recession at one end of the spectrum and a softer landing at the other.
The importance of the American home does not lie so much in its absolute size, although its total value is about $45 trillion. Rather, it serves as an indicator of how the economy is performing amid rising interest rates. Has the Federal Reserve raised rates enough to calm inflation without crushing growth? Have you gone too far? Or maybe not far enough? As one of the first and largest sectors to react to changes, the real estate market offers answers.
Until last month, the evidence seemed clear. Even before the Federal Reserve started raising its policy rate, mortgage lenders, anticipating the bank’s tightening, had started charging more. From 3% at the end of 2021, the rate on 30-year fixed mortgages topped 7% in October, the highest in more than two decades. Lo and behold, activity declined rapidly. Buyers stayed away. Builders cut back on new construction projects. Sellers cut prices. So far, so predictable.
But recently, signs of an early and largely unexpected rebound have emerged, raising concerns that higher rates are not having the desired effect. New home sales rose in January to a ten-month high. Surveys measuring confidence among both homebuilders and homebuyers have improved. Real estate companies in the United States have reported more visitors to their show homes. “We’ve seen the momentum build week after week,” reports Sheryl Palmer, CEO of Taylor Morrison, one of the nation’s largest homebuilders.
The case for optimism is that the US housing market has found a bottom. Shoppers are coming back, but not the frenzy of the covid era. A decent spring season could, in theory, allow house prices to stabilize and builders to resume construction, boosting growth without stoking inflation. The case for pessimism rests on the idea that the interaction between the housing market and inflationary trends is too powerful to ignore: If buyers return to a supply-constrained housing market, prices will rise. And if the Fed sees that a sector as rate sensitive as housing is not responding to tighter monetary policy, it may judge that it needs to be more aggressive. Unfortunately for the United States and the world, the worst case seems more realistic.
Analysts point to a variety of factors behind the rally. After a year of tepid sales, there is pent-up demand. Wealthier buyers, who pay cash, account for a larger share of the market. Buyers may also be getting used to the higher rates: Some saw a good deal when mortgage rates fell from north of 7% late last year to 6% in January.
Perhaps most importantly, the developers have put together a menu of incentives. There is nothing unusual about using discounts when the market is faltering; the novel element, this time, has been the aggressive use of mortgage purchases through internal lenders, in effect, prepaying some interest on behalf of clients to reduce mortgage rates. This has allowed developers to offer mortgages that seem to emanate from the pre-inflation era of the 2010s. Pulte, a homebuilder, has set 30-year fixed rates at just 4.25% on some of its near-complete properties. . Toll Brothers, another builder, is offering 4.99%. “We learned a lot in the past year about how to address consumer concerns,” says Ms. Palmer.
This is clever financial engineering. John Burns, a real estate consultant, estimates that paying 6% of a mortgage up front and getting lower rates over the life of the mortgage saves buyers as much as reducing home prices by 16%. but leaving them with higher rates.
The obvious question is whether such discounts are sustainable. There are two potential drawbacks. Homebuyers would have a hard time reselling their homes at the same price to buyers who don’t take advantage of mortgage reductions. As a result, Mr. Burns believes that appraisers can lower the assessed values of homes, forcing sellers to lower prices. Second, the purchases go against what the Fed has been trying to do: reduce property purchases to better balance supply and demand.
Last year, Jerome Powell, the Fed chairman, spoke of the need for “a bit of a reset” in the housing market. In terms of affordability, this reboot has a long way to go. Mortgage payments on new homes now reach nearly 30% of the median household income in the United States, nearly double its average in the 2010s. An increase in income, a decrease in mortgage rates, or a decrease in prices of housing would return affordability to pre-COVID levels. All three have started to happen, but there is a long way to go. Nationwide, home prices have fallen just 4% from their peak in mid-2022, barely slowing their 45% rise during the pandemic, according to the yes&p CoreLogic Case Shiller Index.
There is also a more inflexible part of the equation: the housing supply. Homeowners who have locked in to low rates are reluctant to move. There are just 1.1 million existing homes on the market for resale, half the average since the late 1980s. Meanwhile, homebuilders are more prudent than they were two decades ago in the run-up to the global financial crisis. . When the covid-buying mania began, homebuilding accelerated but didn’t skyrocket, as developers saw the boom as short-lived. Then, when the market softened, they almost immediately scaled back their activity.
This is good for builders’ balance sheets, leaving them with large cash positions. But it’s bad news for everyone else. Residential construction investment fell by a fifth in real terms last year. It looks like it’s going to drop even more this year. Surprisingly, despite the nascent pick-up in demand, new starts have slowed down so far. Dhaval Joshi’s bca The research notes that similarly large declines in housing investment have almost always heralded recessions in the past. Robert Dietz of the National Association of Home Builders shares this concern: “There really has never been a time where there have been price declines and a significant decline in residential investment, and a recession hasn’t happened.”
This goes against hope in financial markets that the US can avoid a recession, and against hope in housing that the worst is over. Businesses, economists and investors have learned to be wary of inflation fakers over the past two years: brief bouts of falling inflation that give way to a reassertion of price pressures. The housing recovery may also turn out to be a hoax, with the sector on weaker footing than it appears and the Fed forced to keep rates high for longer. The stakes are high in the spring selling season. ■
Illustration: Timo Lenzen