Adobe Stock/Andy Dean

At the onset of the pandemic, the economic outlook was uncertain, due to a fluid environment with many moving parts. During the latest COVID-19 Update webinar, Zonda chief economist Ali Wolf says the state of the current economy “feels a bit similar,” but with many different moving parts than two years ago. The humanitarian crisis in Ukraine, high levels of inflation, Federal Reserve policy, a volatile stock market, and increasing mortgage rates have impacted the economy and caused it to deviate from many projections from earlier in the year.

“We are at a 40-year high with inflation. The hope was that as this year progressed the supply chain was going to get a little bit better, and we would see downward pressure on pricing,” Wolf says. “This is where black swans—things you can’t forecast—come into play. The geopolitical tensions that we are seeing with Russia and Ukraine are putting some additional inflationary pressures on us, and that’s making forecasting inflation a little bit harder than we initially thought.”

While Wolf shared in the January COVID-19 update that leading economists forecast inflation ranging between 2.7% and 7.5% in 2022, the Consumer Price Index and Personal Consumption Expenditure indices show current inflation is between 6.5% and 8%. Inflationary pressures are only going stronger after sanctions against Russia have caused oil prices to rise. Products with oil as an input to production have experienced price increases, and rising gas prices are having a disproportionate impact on the discretionary spending of low-income individuals, according to Wolf.

“Our housing industry has been so lucky that we have the work-from-home [environment] and people are willing to move farther away because that’s where the land and lots are and that’s where [builders] can provide homes, but, if oil prices stay high, will people continue to be willing to move farther away? It’s not that oil prices are up or going through this temporary shock, it’s how high do oil prices go and how long do they stay [high],” Wolf says. “If they go high and stay there long, that’s when you see more demand destruction, [and] that’s when you start to see some more permanent changes or some lifestyle changes.”

The Federal Reserve, in an effort to combat the high records of inflation and help the economy return to more “sustainable” and “healthy” levels, enacted the first of many planned short-term interest rate increases in March. After the 25-basis point increase, the Federal Reserve says six more short-term rate increases are likely before the end of the calendar year. Wolf says the actions by the Federal Reserve, while attempting to cool the economy, could have the unintended effect of bringing on a recession, called a hard landing.

“The Federal Reserve does not want a hard landing, they do not want a recession. But they are raising these short-term interest rates—and data can be lagged. So they’re raising interest rates and trying to see if it slows the economy, and sometimes they don’t know the answer and they may overdo it,” Wolf says. “Hard landings, historically, are more likely than a soft landing [where rate hikes directly contribute to market normalization and a healthy economy].”

Mortgage Rates and the Housing Industry
While the Federal Reserve is not directly changing mortgage rates with the short-term interest rate increase, they are influencing how investors view the economy. As a result, the 10-year Treasury has increased much faster than anticipated, and mortgage rates are also beginning to increase.

“Just like the economy is too hot for its own good, the housing market is too hot for its own good,” Wolf says. “Rising mortgage rates are supposed to slow the level of demand.”

Despite rising mortgage rates, demand for housing remains high, according to Wolf. People who have been actively looking for homes are rushing to buy because of the rising mortgage rates, home price appreciation, and low levels of inventory.

Wolf says 69% of homes on the resale market are currently facing bidding wars, driving up prices and negatively impacting affordability. Zonda’s New Home Pending Sales Index indicates that growth rates in many markets are up between 60% and 90% compared with two years ago.

“Ninety-seven percent of builders reported raising prices month over month through mid-March, and 60% of builders are raising prices $10,000 or more,” Wolf says. “Prices are rising partially due to the supply-demand imbalance, but a lot of it has to do with cost increases. When costs go up for the company, [the costs] are getting passed on to consumers, and, for now, we have consumers that are willing to continue to buy because of the overall backdrop for inventory.”

Unemployment and High-Income Jobs
Amid all the economic uncertainty and recession risks, the labor market in the U.S. remains very strong. While the number of employed individuals is 2 million below pre-pandemic levels, Wolf says many of the people that aren’t in the labor force “are doing it by choice.” Since the pandemic, the unemployment rate has not been a strong indicator of housing market health. Several markets with high unemployment rates, such as Los Angeles, have strong housing markets. Wolf says high-income jobs, however, are a strong indicator of housing strength. High-performing markets, such as Dallas; Austin, Texas; Jacksonville, Florida; and Raleigh, North Carolina, have recovered and grown the number of high-income jobs in their local economies compared with 2019.

“We know that people will buy homes regardless of their role as long as they have some money that they can put toward it,” Wolf says. “The unemployment rate [may] be high [in some markets], but you’ve got a lot of high-income people looking to buy homes, and that’s supporting growth.”

Real-Time Housing Data
Zonda senior managing principal Tim Sullivan says many builders are prioritizing specs above customization in the current environment.

“The concept of allowing a buyer to come in and customize homes just isn’t making sense right now,” Sullivan says. “The conversation is focusing on specs, getting the home built, getting it sold, and moving on to the next one. While many builders don’t prefer that approach, that is what is going on based on all the economic factors and certainly from the standpoint of how the market is changing.”

Many builders are continuing to cap sales, but the sales rate in many high-performing markets, including Riverside and San Bernardino, California, are between 20% and 50% higher than three years ago in spite of restrictions by builders. Sullivan says there is approximately a 60% decline in active listings on the resale market nationwide compared with five years ago, which is one factor in rising prices. Rising prices are beginning to have impacts, though, with Sullivan suggesting nearly half of builders are seeing buyers become unqualified and an increasing number of builders reporting overall buyer hesitancy.

Sullivan says builders' biggest worries in the current environment are strongly tied with cost. Most builders are concerned about building materials cost and availability, rising mortgage rates, inflation, and land prices. Additionally, a majority of builders are still reporting supply disruptions, ongoing labor shortages, land disruptions, and challenges related to government services.