Paul Blow

November 2022 may well go down as a new low-water mark for the U.S. home building economy. The average rate for a 30-year, fixed-rate mortgage peaked at 7.08%, driven largely by four successive 75-basis-point (bp) interest rate hikes by the Federal Reserve. Builder confidence in the market for newly built single-family homes as measured by the NAHB/Wells Fargo Housing Market Index declined for an 11th straight month, and research from indicated that the country was facing a housing shortage of some 5.24 million homes, an increase of more than 36% (and approximately 1.4 million additional homes) from just three years prior.

Jerry Konter, NAHB 2022 chairman and owner of Savannah, Georgia–based Konter Quality Homes, used the occasion to officially declare the housing sector in recession, pointing to weakened demand and increasingly scarce buyer traffic as warning signals that the federal government needed to address an emerging bear market with “policies that lower the cost of building and allow the nation’s home builders to expand housing production.”

By year’s end, the Fed had eased pressure on interest rates with a smaller, 50-bp increase in December, in a hopeful signal that efforts to moderate and contain inflation were taking hold, but the cumulative damage of a 4.25% increase to rates on the year had already taken its toll: Designed to cool inflation by curtailing both borrowing and spending, interest rate increases counted the housing economy among its collective collateral damage, and the pace of sales hit lows not seen since the housing crisis over a decade earlier.

Paul Blow

“Home buying actually decelerated much faster in 2022 when compared with those 2008 and 2009 markets,” says Marc Russo, co-founder and CEO of Mercer Island, Washington–based JayMarc Homes. “It was like the pandemic in that it was one of those once-in-100-year events. We didn’t even see interest hikes like this in 1980. As a result, we slowed our starts and closed on about a dozen homes last year and deliver about a dozen homes this year, reducing our exposure to market by half. At this stage of the cycle the goal is not necessarily how much profit can be gained, it’s how to keep the lights on and employees employed.”

During a Dec. 15 earnings call, executive leaders for Miami-based Lennar, the nation’s No. 2 builder based on closings, concurred with the industry’s dour view of the housing market, and while the big builder ended 2022 with record revenue, profit, and liquidity, year-over-year sales were down 15% while cancellations had shot up to 26%.

“The well-documented interest rate–driven sales slowdown and pricing correction has intersected with the still-stressed supply chain, high labor and material costs, and elongated cycle times to make for a very complicated landscape,” Lennar executive chairman Stuart Miller noted on the call. “The sudden movement in interest rates has very quickly affected both affordability and consumer confidence, resulting in rapid changes to market conditions and demand. Sales and sales prices are down materially across both new and existing home markets, and giving commercial lending underwriting and lending criteria, new for-rent properties are being curtailed as well.”

If anything, the housing shortage per se should be driving—and continuing to drive—demand for new-home purchases, if not for extremely low inventories that push prices higher even as financing stays costly for the preponderance of noncash buyers. But higher mortgage rates also keep existing home sales low, and as owners with lower, locked-in interest rates stay put, new-home sellers typically benefit from the first waves of demand as the market rebounds, offering a ray of hope to home builders in the coming year.

The Meyer Plan 4 from Tri Pointe Homes in Fallbrook, California, includes three to four bedrooms and two-and-a-half baths.
Courtesy Tri Pointe Homes The Meyer Plan 4 from Tri Pointe Homes in Fallbrook, California, includes three to four bedrooms and two-and-a-half baths.

“2023 is looking like it may be a tough year for the housing industry, but taking a step back and looking at specific economic factors may help put things into perspective,” says Doug Bauer, CEO of Incline Village, Nevada–based Tri Pointe Homes. “Unemployment remains low, and there is still a housing deficit that has fallen short of meeting household formations since 2009. Homeowners with low mortgage rates will probably not move, so buyers are more likely to purchase from new-home builders rather than purchasing a resale home. Income levels are strong, so once rates settle and demand picks up, builders like Tri Pointe will look to adjust pricing to payment and consumers should reengage.”

Like many builders, Tri Pointe is leveraging incentives such as closing cost contributions, design studio credits, and refreshed pricing on available move-in ready homes to drive additional traffic and help close deals. According to the NAHB, the number of builders using incentives surged to 59% in the fourth quarter of 2022, with big increases in the number of builders paying points for buyers, initiating mortgage rate buydowns, and reducing prices (by 6% on average).

Still, Bauer says pricing adjustments in and of themselves aren’t the silver bullet to 2023 demand softness, and Tri Pointe is reacting with new financing options and product design specifically focused on the affordability question for buyers.

“While our market locations aren’t changing, many of the new communities we opened in 2022 and expect to open in 2023 have been planned and designed with product, features, and amenities to help address the affordability challenges that today’s interest rate environment presents,” Bauer explains, pointing to the company’s Citro planned community in San Diego County that features an attached product offering of homes ranging from 1,083 to 1,480 square feet and priced from the $400,000s.

Pisgah View is a 7,648-square-foot custom home built by Judd Builders and located in The Farm at Mills River near Asheville, North Carolina.
Courtesy Judd Builders Pisgah View is a 7,648-square-foot custom home built by Judd Builders and located in The Farm at Mills River near Asheville, North Carolina.

Builders at the luxury end of the market— particularly ultra-high-end custom builders—are conversely benefiting from a bifurcation in the buyer’s market and report seeing little trepidation from high-net-worth individuals eager to get under contract and allocate larger portions of their assets to real estate. John Judd, who started Asheville, North Carolina–based Judd Builders with his father in 2007, says today’s environment barely resembles their first few years navigating the housing crisis.

“We got a good taste of a depleting market very early and learned a great lesson not to overextend ourselves,” says Judd, who will carry a full log of half a dozen $2 million custom builds into 2023 and plans on several whole-house remodels as well. “Although we have challenges, we don’t feel the slowdown in this market. Seventy-five percent of our clients are paying cash, particularly considering the current interest rates. Before, money was free at 2%, and we are seeing less people financing now, but for a lot of our clientele this is their final home, they’re not highly invested into equities and have been saving to do this.”

With an average sales price of $2.8 million across markets in California, Colorado, Arizona, and the Pacific Northwest, Redwood City, California–based Thomas James Homes likewise hit all targeted starts last year and plans to deliver 400 homes and secure 100 service contracts to build in 2023, with supply chain challenges and land availability the only wild cards holding the builder back.

“Our starts and acquisitions were on target for 2022, but supply challenges stalled deliverables,” says Thomas James chief sales officer Brian Reid. “We are conservatively positive about next year, but we’re also not competing with traditional tract home builders, we’re building new detached homes in a single lot replacement business model, all noncontiguous infill. We’re staying real about challenges with interest rates and inflation, but jobs in our markets are strong.”

A 5,520-square-foot, five-bedroom, eight-bath modern farmhouse built by Thomas James Homes in Beverly Hills, California.
Courtesy Thomas James Homes A 5,520-square-foot, five-bedroom, eight-bath modern farmhouse built by Thomas James Homes in Beverly Hills, California.

By using a proprietary dynamic pricing model that flexes margin in order to preserve volume and production, Lennar expects 68,000 starts in 2023, a delivery that would be flat year over year but still strong relative to a new-home construction market that the builder has forecast to drop by up to one-third.

“Our current view is that production of single-family and multifamily dwellings nationally will drop from 1.5 million to 1 million homes,” Miller said during the earnings call. “The supply chain overhang, stubbornly high labor and material costs, and production cycle times that have grown over two months have created an unusual wedge that home builders need to navigate.”

Judd agrees that supply chain delays remain a major stressor to new-home deliveries and, compounded with uncertain labor availability and costs, will continue to pressure business operations across 2023. “Supply has been an absolute nightmare. From 18-month lead times on appliances to 25-week lead times on windows, it is the hardest it has ever been to build a house,” Judd says. “We have a heavy book for this year, but the problem is getting materials and finding qualified labor to do the work.”

In addition to availability, material costs continue to stress builders of all sizes, even as savvy operators look to preserve cash and boost liquidity, with NAHB chief economist Robert Dietz noting that even as home pricing corrects, costs for labor and materials—particularly concrete—have yet to follow.

The Pennington plan offered at Lennar's Chatham Village in Westfield, Indiana.
Courtesy Lennar The Pennington plan offered at Lennar's Chatham Village in Westfield, Indiana.

“Entering this cycle is all about cash preservation, and every dollar and every nickel becomes super important,” Russo says. “You have to look at every outflow from the general and administrative to overhead to the snacks in the office. The focus is how to sell enough to live another day and keep as many A-plus employees as possible to not just make it but be ready for the next market, and having cash in the bank is critical to that effort.”

Lennar, for one, is using its purchasing brawn as a lever to influence trade partners—from supply houses to land sellers—to readjust pricing. “Make no mistake, Lennar led the way with reduction in margin while maintaining volume as the market has corrected, and we expect our trade partners to work side by side with us and follow suit,” Miller said.

In the fourth quarter of 2022 alone, the big builder renegotiated or walked from deposits on approximately three-quarters of its $2.5 billion in land holdings (see page 58). “We are relentless in preserving cash,” Miller said. “Like our trade partners, our land partners need to recognize that we are taking the first hit to our margin in order to maintain production and volume, and they will need to participate or move on.”

Lennar will carry $4.5 billion in cash on hand into the year, but conditions are unlikely to support the planned spinoff of the firm’s Quarterra multifamily development division. Even as the apartment side of the industry experienced historic rent growth in 2022, the impact of interest rate hikes to construction lending coupled with similar material costs and supply challenges have severely constricted development pipelines. For veteran multifamily builders with established lender relationships, the absorption of new apartments coming out of the ground is expected to remain swift due to the housing shortage, which should continue to support strong pricing.

The Chelsea luxury apartment building, located in the Fells Point neighborhood of Baltimore, by Chasen Co
Courtesy Chasen Cos. The Chelsea luxury apartment building, located in the Fells Point neighborhood of Baltimore, by Chasen Co

“We can’t build fast enough,” says Drew Peace, chief business development officer for Baltimore–based Chasen Cos., which builds ground-up communities and acquires distressed properties and warehouses for adaptive reuse into luxury apartments. “We have our construction in house and have the local relationships to get ahead of approvals and usually start building on the day we close on a property. We have a lot of good partnerships with our lenders because of that. We build fast, stick to our timelines, and refinance without issue.”

And while strength in the multifamily market and demand for rentals isn’t exactly great news for the household creation that powers single-family sales growth, builders large and small are remaining conservatively optimistic that, relative to the last housing crisis, the economy as a whole and job growth in particular puts the industry on better footing to endure what will prove to be a dynamic market in 2023.

“The positivity is that job numbers are good and people have money and are spending [it], it’s just that consumer confidence has gone down fast, and it’s the real estate market where we typically see and feel that the most,” Russo says. “The economy is a glimmer of hope, and, as a builder, you have to plan accordingly, weather the storm, and keep as many talented people on the payroll as possible so when the uptick comes, you have a team ready for the next opportunity.”