This video is the latest in our Monday with Matthew series with Windermere Chief Economist Matthew Gardner. Each month, he analyzes the most up-to-date U.S. housing data to keep you well-informed about what’s going on in the real estate market.

Hello there, I’m Windermere’s Chief Economist Matthew Gardner and welcome to this month’s episode of Monday with Matthew. Today we are going to take a look at the new home market where headwinds are certainly growing. And the reason this particular subject piqued my interest was that the National Association of Home Builders just released their Housing Market Index for August, and the numbers were certainly eye-opening.

Now, for those of you who may not be particularly familiar with this index, it is based on a survey of home builders which asks them to give their opinions on the single-family home market and asks them to rate current market conditions for the sale of homes today as well as in six months’ time. It also asks their opinion regarding foot traffic of prospective buyers to their new home communities.

NAHB Housing Market Index

And as you can see, the headline index level fell six points to 49. The drop in August marked the eighth consecutive monthly decline for the Housing Market Index. It was also notable because it was the first time since May of 2020 that the index has dropped below the key 50 breakeven level. This is significant, as it tells us that today more home builders currently rate sales conditions as poor than good.

Now, while the August number was certainly lower than some economists had forecast, I was actually not too surprised as builders have been reporting a spike in cancelled contracts recently. In fact, a report I just read that was put out by John Burns Consulting suggested that the cancellations have more than doubled since April with 17.6% of buyers pulling out of their purchases in July. That compares to 8% in April and 7 ½% a year ago.

Housing Market Index Components

This chart shows a breakdown of three components of the Housing Market Index which are all at their lowest levels since May of 2020, which was just before housing activity rebounded following the lockdown due to COVID-19.

• The present sales index fell seven points to 57 but is still above the breakeven point
• The future sales series fell two points to 47
• Prospective buyer traffic fell five points to 32 which, if we exclude the pandemic, represents the lowest index level since April of 2014

I find this index has a very strong correlation with new home sales, but I also use it as a pretty reliable leading indicator when it comes to single-family housing starts. I’ll get to that shortly. The survey also stated that one in five builders had reduced prices in August. That might help to explain the 10-point spread between builders’ perception of current versus future sales. But there are limits on home builders’ ability to keep cutting prices in order to support sales. This has become a significant issue because many of them are currently holding a large stock of inventory.

New Homes for Sale

Here is what current inventory levels look like. Although you might think that it’s not that bad given that only 9% of available homes are finished are ready to move into, I would tell you that builders incur costs every day that a home is not sold, even if that home has yet to be built. And with inventory at a level not seen since 2008, I’m sure there are a lot of builders not sleeping too well right now.

I would add that by the time the above video is released, the July new home sales report will have been published. I can almost guarantee that the number of homes for sale will have grown further.

New Home Sales

Higher inventory levels are due to slower sales activity, which is continuing to decline. Sales are 17% lower than a year ago. With more homes for sale and lower transactions, it would now take more than nine months to absorb all available homes using the current sales pace. I would also tell you that the last time months of supply broke above nine was all the way back in 2010.

• It’s my forecast that sales in July will have dropped from the annualized rate of 590,000 shown in the chart above to somewhere between 570,000 and 580,000.

U.S. Single-Family Housing Starts

With high supply levels and lower sales, it’s not at all surprising to see builders hitting the brakes, with new home starts falling by 10.1% between June and July of this year. Starts are down by 18 ½% from a year ago. Starts have dropped on a sequential basis for five consecutive months now, and I am afraid that they will drop further before finding a bottom.

So, what’s the bottom line here? Well, there are several issues I see, the first of which is affordability. Home prices have been spiraling upward since the start of the pandemic not only because mortgage rates dropped, but construction costs started jumping and builders had to charge more for a home.

Builders saw prices rise by almost 18% last year. This had already taken a significant toll on affordability even before the mortgage rates spike we saw earlier this year. The upshot, as I see it, is that tighter monetary policy from the Fed, in concert with construction costs that remain well above normal levels, has hit builders and hit them hard. Of course, they are doing their best to address the situation by slowing construction activity significantly, but I think that they are going to have a pretty rough time for the next several months.

Ultimately, I see little option for home builders other than lowering prices further, especially now that they are competing with rising inventories in the resale market. I also believe that there are buyers out there waiting patiently on the sidelines for prices to drop in the coming months as they know that builders at some point have to solve the current supply demand imbalance and lowering prices is the easiest way of doing this. Last month the average price drop was 5%, but this is very likely to increase as we move toward the fall.

Will builders get through the situation they find themselves in? I believe that they will. And there are some glimmers of light out there with inflation appearing to be peaking, interest rates are, if not dropping, then certainly stabilizing, and this will help.

Builders also understand that the country has a significant housing shortage. In fact, a recent report published by “Up For Growth” suggested that we have a housing shortage today of around 3.8 million homes. Although this includes rental and ownership housing, some basic math tells me that there is a need today for around 2.5 million new owner-occupied homes. So, light is definitely at the end of the tunnel, but there is a way to go before they get out of it.

And there you have it. I hope that you’ve found my thoughts on this topic of interest. As always, if you have any questions or comments about the current new home environment, please do reach out to me. In the meantime, stay safe out there and I look forward to visiting with you all again next month.

Bye now.

About Matthew Gardner

As Chief Economist for Windermere Real Estate, Matthew Gardner is responsible for analyzing and interpreting economic data and its impact on the real estate market on both a local and national level. Matthew has over 30 years of professional experience both in the U.S. and U.K.

In addition to his day-to-day responsibilities, Matthew sits on the Washington State Governors Council of Economic Advisors; chairs the Board of Trustees at the Washington Center for Real Estate Research at the University of Washington; and is an Advisory Board Member at the Runstad Center for Real Estate Studies at the University of Washington where he also lectures in real estate economics.

This video is the latest in our Monday with Matthew series with Windermere Chief Economist Matthew Gardner. Each month, he analyzes the most up-to-date U.S. housing data to keep you well-informed about what’s going on in the real estate market. 

Hello there, I’m Windermere’s Chief Economist Matthew Gardner and welcome to this month’s episode of Monday with Matthew. You know, one of the many things I love about being an economist is that it is a remarkably humbling profession. You see, just when we start to believe that our models are close to perfection, something comes along to remind us that forecasting isn’t an exact science.

And if you’re wondering what I am talking about, I recently took a look at the 2022 mortgage rate forecast I put out at the start of the year and…well, let’s say that rates rose at a far faster pace than I had anticipated. I thought that now would be a good time to take another look at rates and share my thoughts on the direction that they will likely take during the rest of the year and my reasoning behind it. And that means we need to talk about inflation.

30-Year Conventional Mortgage Rates: 2018 – 2022

So, a quick look back. As you can see, there wasn’t much to celebrate in 2018, with rates rising from 3.95% to 4.94% before pulling back and ending the year at around 4.5%. In 2019, rates fell following the Feds’ announcement that they were likely done with raising the Fed Funds Rate, and the mortgage market also reacted positively to the announcement from the White House that they were going to impose tariffs on select Chinese imported goods. We saw an uptick in late summer, but that was mainly due to news related to BREXIT.

In 2020, rates were dropping but spiked very briefly when COVID-19 shut the country down and bond markets panicked. But with the Fed jumping in with an emergency rate cut and announcing that they would start buying a significant number of treasuries and mortgage-backed securities, rates tumbled to an all-time low of just 2.66%. In 2021, rates rose as new COVID infections plummeted, but then dropped again as the Delta variant took hold, but ultimately trended modestly higher in the second half of the year.

And then we get to 2022. Rates started the year at just over 3.1% but have since skyrocketed to over 5.8% before a small pullback that started a few weeks ago. In as much as economists expected rates to rise this year, nobody anticipated how fast they would rise. So, what went wrong? Well, there’s actually a rather simple answer.

Even though we expected rates to trend higher in 2022, there were two things we hadn’t built into our forecast models.

1. Russia’s invasion of the Ukraine
2. Inflation continued to climb for far longer than we expected

So, how do things look for the rest of the year? To explain my thinking, it’s important to remember that the bond market and, by implication, mortgage rates hate nothing more than high inflation because when inflation is running hot, it limits demand for bonds which, in turn, forces the interest rate payable on bonds to rise and this pushes mortgage rates higher.

But what’s been fascinating to watch is that over the past couple of weeks, rates have actually been dropping which is certainly counterintuitive given where inflation is today. And the only reason I can see for this is that bond traders were thinking that inflation might be topping out.

But then we got the June CPI numbers, and it certainly didn’t suggest that inflation was slowing, in fact it showed the opposite. But even though the total inflation rate hasn’t yet peaked, I believe that a shift has actually started and that we are closer to a peak in inflation than you may think.

Indicators of Inflation: Consumer Spending

The June CPI report showed the headline inflation rate still trending higher but look at the core rate which excludes the volatile food & energy sectors. That has actually been pulling back for the past three months. And consumer spending when adjusted for inflation fell 0.4% in May. That’s the first monthly drop since last December, and I expect the June number when it comes out at the end of the month to show spending dropping even further.

This is a very important dataset that often gets overlooked but it is starting to tell me that the economy is slowing because of inflation and slower spending acts as a headwind to further price increases.

The core PCE price index is up 4.7% year-over-year, but this was the smallest annual increase since last November and you can see that it is also starting to roll over. This index is actually the Fed’s favored measure of inflation as it’s more comprehensive that the CPI number as it measures the change in spending for all consumers, not just urban households.

Indicators of Inflation: 5-Year Breakevens and Producer Price Index

The five-year “inflation breakeven” has plunged more than a full percentage point since peaking at just under 3.6% in late March. And this number is important as it lets us know where bond traders expect the average inflation rate to be over the next five years.

The Producer Price Index measures inflation at the wholesale, not retail, level and even though the total rate rose as energy costs continue to impact the manufacturing sector, the core rate has been pulling back for the past three months. Now let’s look at some commodity prices and see what’s going on there.

Selected Commodity Prices: Natural Gas, Copper, Soybeans, Wheat

• The price for natural gas is down over 34% from its recent high
• Copper prices are down 26% from the recent June peak and down substantially from March
• Soybean prices are down 10%
• Despite the war in Ukraine, wheat prices are down 27% from June

Retail Gas Prices: West Coast, West Coast Excluding CA, U.S.

It appears as if gas prices have also rolled over. Of course, here on the West Coast it’s more expensive than the nation even when you take California out of the equation.

U.S. Treasury Yields: 10-Year and 2-Year Constant

And finally, to cap things off, traders must also be pondering the same numbers as I am because bond yields themselves have been tumbling at both the long and short ends of the yield curve with the 10-year note still yielding less than 3% even after the CPI report and two-year yields, while still elevated, are still down from 2.42% just two weeks ago.

So, given all the charts we have looked at, I hope that you too are seeing some light at the end of the tunnel when it comes to the likelihood that inflation is about to start easing.

No doubt, the headline inflation number for June wasn’t one that anyone wanted to see but, if the trends we have looked at continue, I still expect inflation to start slowly creeping lower, which will push bond prices higher, yields will start to pause—if not drop—and that will allow mortgage rates to hold at or close to their current levels for the time being. Although we could see rates coming down, though they will still start with a five for the foreseeable future. I hope that you have found my thoughts of interest.

About Matthew Gardner

As Chief Economist for Windermere Real Estate, Matthew Gardner is responsible for analyzing and interpreting economic data and its impact on the real estate market on both a local and national level. Matthew has over 30 years of professional experience both in the U.S. and U.K.

In addition to his day-to-day responsibilities, Matthew sits on the Washington State Governors Council of Economic Advisors; chairs the Board of Trustees at the Washington Center for Real Estate Research at the University of Washington; and is an Advisory Board Member at the Runstad Center for Real Estate Studies at the University of Washington where he also lectures in real estate economics.

This video is the latest in our Monday with Matthew series with Windermere Chief Economist Matthew Gardner. Each month, he analyzes the most up-to-date U.S. housing data to keep you well-informed about what’s going on in the real estate market. 

Hello there, I’m Windermere’s Chief Economist Matthew Gardner and welcome to this month’s episode of Monday with Matthew.

If you’ve listened to me at all over the past several years, you’ll know that I am pretty passionate about one subject: housing affordability. And, given the significant price growth that we’ve seen over the past decade, as well as the recent spike in mortgage rates, I wanted to talk a little bit about what might be done to address this very serious issue.

The Growing Housing Affordability Problem

Now, when we think about housing affordability and how it might be solved, a lot of people get tied up in the minutiae when, quite frankly, it really isn’t that hard a problem to solve. You see, there’s one very simple way to address this: to build more housing units. But, as easy as that may sound, there are a lot of obstacles that are holding new supply back. But before I get to that, I want to share some data with you that might help to demonstrate how serious an issue we all face.

Every quarter, the National Association of Homebuilders puts out its affordability numbers for metro areas across the country. An analysis of sales and incomes allows them to show the number of homes—both new and existing—sold in a quarter that were affordable to households making median income.

Housing is Increasingly Unaffordable

Here you will see numbers from just a few of the 240 metropolitan areas across the country and the share of sales in the first quarter of this year that were “technically” affordable. I think you’ll agree that it’s eye opening.

Although I am only showing you a few of the U.S. markets I will tell you that the ten least affordable US housing markets were all in California. The Golden State is also home to 21 of the top 25 least affordable markets in the country. But what you might also find interesting is that our primary cities aren’t the only ones that are suffering from affordability issues, with markets like Bend, Oregon; Boise, Idaho; and even Las Vegas, Nevada becoming increasingly unaffordable for a lot of households.

And it’s worth mentioning that that 48 of the 69 markets where less than half of the homes sold were affordable were in states that have at some point in the past implemented comprehensive planning and growth management legislation. And when governments mandate where homes can and cannot be built, one thing happens: it pushes land prices higher which makes new homes more expensive and limits the amount of new supply that builders are able to provide. So, what can be done?

Well, I will start out by saying that states who have implemented growth management plans, which they generally did to slow or stop suburban sprawl, remain disinclined to move these boundaries, and that means it becomes paramount to not look further out but to concentrate within the urban growth boundaries and decide whether it’s time to think about removing single-family zoning altogether.

This is a fascinating thought, but I must add that I am not suggesting that we do away with single-family homes. Absolutely not! What I am thinking about is the ability for a market to decide what makes the most sense. In order to do so, single-family zones need to allow for the development of denser housing, but also allow the market to decide what’s best. Areas that have implemented such change has given rise to a movement in order to address what is being referred to as “missing middle housing.” For those of you who are unfamiliar with this term let me try and explain.

Missing Middle Housing

This is a great image courtesy of Opticos, a team of urban designers, architects, and strategists who are passionate about adding sorely needed housing options.

They came up with the term “missing middle” as it describes housing types that were actually very common prior to World War II where duplexes, row-homes, and courtyard apartments were in high demand. Unfortunately, however, they are now far less common and, therefore, “missing.”

And the key function of this type of housing is to meet the rising demand for walkable neighborhoods, respond to changing demographics, and provide housing at different price points. You see, rather than focusing on the number of units in a structure—think high rise apartments or condominiums—this type of housing emphasizes scale and heights that are appropriate for and sympathetic to single-family or transitional neighborhoods.

The Decline of Missing Middle Housing Construction

And to show you how supply of these types of units has changed, this chart shows the number of duplexes to eight-unit buildings built over the past almost half-century and you can clearly see that up until the late 1980s they were being built in decent numbers, but the 1990s saw a significant shift toward traditional single-family home ownership and builders followed the demand and this type of product started to become scarcer.

Almost 16% of total new homes built in America in the early 1980s were of this style, but that number has now shrunk to just 1.4%—or a paltry 19,000 units.

But I see demand for these housing types growing as we move forward and that buyers or renters, young and old, will be attracted as it will meet their requirements not only in regards to the type of home they would want to live in but, more importantly, it can be built cheaper than traditional single-family housing and therefore it will be more affordable.

But although this sounds like it’s a remarkably simple solution that can solve all our woes, in reality it’s not that easy for two very specific reasons. The first is that many markets are already essentially built out, meaning that in order to develop this type of product, a builder would have to purchase a number of existing homes and raze them in order to rebuild. But given current home values, it’s very hard for a builder to be able to make such a proposal financially.

And the second issue is that current residents within these “transition” areas—which have been developed as traditional single-family neighborhood—simply don’t want to see change. But is this type of product bad? Here are some examples.

This shows row-homes in Brooklyn on the left and traditional “triple-deckers” in Massachusetts on the right:

This is a bungalow court project in California:

Here are some Live/Work Units in Colorado:

These are some amazing mews homes in Utah:

And finally, a new terrace housing project that will be built in Washington DC:

Don’t get me wrong, I’m sure that some of you who simply aren’t inspired by this type of architecture, and that is understandable. But can we simply stick with the status-quo? I don’t think so. And some state legislators have already implemented significant zoning amendments in order to try and encourage this type of development.

Back in 2018, Minneapolis was the first city to allow this type of development inside single-family zoned areas. This was followed by Oregon State in 2019. Senate Bill 9 was signed by Governor Newsom of California last year which made it legal for property owners to subdivide lots into two parcels and turn single-family homes into duplexes, effectively legalizing fourplexes on land previously reserved for single-family homes. So, we are starting to see some change.

This is a good start but as I mentioned earlier in areas that are already built out, even this type of forward-thinking legislation will not be the panacea that some want. But I’m not giving up hope.

Addressing the “missing middle housing” would allow for homes of all shapes and sizes, for people of all incomes including workers who are essential to our economy and community. Here I am talking about our teachers, firefighters, administrative assistants, childcare providers, and nurses—just to name a few!

There are currently 45 million Americans aged between 25 and 34 and most aspire to homeownership. However, the massive price growth which, by the way, many of us have benefitted from over the past several years, has simply put a “starter home” out of their reach.

I will leave you with one last statistic. Over 28% of American households today are made up of a single people living alone, and it is anticipated that up to 85% of all U.S. households will not include children by the year 2025. Finally, by 2030, one in five Americans will be over the age of 65.

Are we going to meet the needs of the country’s changing demographic going forward? I certainly hope so, but it will take a lot of work for us to get there. As always, if you have any questions or comments about this particular topic, please do reach out to me but, in the meantime, stay safe out there and I look forward to visiting with you all again next month.