Adobe Stock

With mortgage rates rising above 7% to their highest level in over 20 years, affordability remains a chief concern in the housing market at a time when high prices and the lock-in effect are contributing to limited resale supply.

In response to tight affordability conditions, builders are continuing to offer incentives, such as interest rate buydowns, and are beginning to reduce the size of product to help cost-concerned buyers attain homeownership, Zonda’s Ali Wolf and Tim Sullivan shared during the most recent Housing Market Update Webinar.

The rise in interest rates has caused a 72% increase in the typical monthly payment since the beginning of 2022, including increases of 80% in some markets. However, despite the affordability shock, 40% of builders surveyed by Zonda indicated that demand is on track with expectations given the current interest rate environment. An additional 25% indicated demand is slower than expected, but not worrisome, while 12% of respondents indicated demand is slower than expected and is a cause for concern.

“When you dig into the comments [from the 12% of builders], the concerns come down to what’s happening with rates and affordability,” Wolf, Zonda’s chief economist, said during the webinar. “[Builders said] funds to close and monthly mortgage payments are much higher than many buyers can handle, and the market is slowing down. There’s strong interest, but financing remains the main issue. I think it would be surprising if there wasn’t a bit of a sentiment shift.”

Wolf said compared with when interest rates rose in 2022—jumping from the 3% range to the 6% to 7% range very quickly—the relative stability of high interest rates in 2023 means that cancellation rates likely won’t reach the high levels experienced last year.

“[Last year] cancellation rates had spikes, demand pulled back, and confidence had been hit, [so] builders ripped the Band-Aid off and found the market. So throughout this year, the majority of builders have been raising prices; we were over 50% in May and June, and 44% of builders raised prices in July,” Wolf said. “We are now at 37% for August. [Builders] do have this pricing power but need to be really cautious with what they do because of affordability.”

While incentives have become less prevalent among builders—offered in 58% of new-home communities in July, down from 63% in June—they remain popular among builders in markets that have grown the most rapidly in the past few years. Over 80% of builders in Florida's Jacksonville, Orlando, and Tampa; Denver; Indianapolis; Phoenix; and Raleigh, North Carolina, are offering incentives, including mortgage rate buydowns, funds toward closing costs, and flex dollars to help overcome affordability hurdles.

On the supply side of the equation, Sullivan, Zonda’s chief advisory officer, highlighted how builders are offering smaller homes and fewer specifications to help tackle the affordability challenge.

“This is a classic response to a market that is less affordable. The change in square footage in just the last six years is from 2,700 square feet down to almost 2,400 square feet,” he said. “[Size] is probably the lever that builders have the most control because just [by] reducing the square footage, you’ve reduced the cost [to build] and ultimately reduced the price.”

While affordability and prices remain a concern for many buyers, projections indicate that the annual number of home sales—accounting for new and existing homes—will reach approximately 5 million in 2023. Wolf said many “life happens” buyers, including new parents, recently married couples, baby chasers, recent divorcees, and recent retirees, are buying not because of great timing, but because of the reality of their life stage.

Mortgage Rates and Future Expectations

Wolf highlighted how the realization of higher-for-longer rates, funding the federal government’s obligations, and a change in international appetite have contributed to “mortgage rates not only going back above 7%, but holding above 7%.”

“You have this increased supply of the treasuries from the Treasury Department, you have this smaller appetite from investors and buyers, which is leading to higher yields. There’s a near-perfect correlation between bond yields and mortgage rates, so those higher yields are translating into higher rates,” Wolf said.

Despite conditions that have supported higher mortgage rates, Wolf shared that most economists believe interest rates will decline by the end of the year to ranges between 5% and 6%.

“The reason there’s a little bit of confidence in rates coming down is the 10-year treasury spread and the mortgage rate spread, and how it’s elevated right now,” Wolf said. “It usually compresses between 12 and 24 months, so there’s reason to believe that we’re going to see rates come down a bit.”

Real-Time Housing Stats

Among respondents to Zonda's survey, more than 50% of builders reported that they anticipate increasing starts in 2023. Additionally, 76% said they expect starts to be up in 2024, partially due to increased lot supply. The increased appetite for starts is a positive sign for a housing market that remains underbuilt, and additional houses is one method of addressing affordability.

Builders also reported cycle times have continued to improve throughout 2023. As recently as October 2022, a majority of builders reported cycle times in excess of eight months, with nearly a quarter experiencing cycle times of 13 months or more. However, in August, approximately 80% of builder respondents reported cycle times between four and seven months. Sullivan said the improved cycle times not only benefit builders’ financial results, but they also allow companies to respond more quickly to the market and deliver on consumer demands.

Sullivan said headwinds for builders remain in the land market, where 43% of builders indicated that prices are increasing compared with a few months ago. The share is a marked increase from March, when between 7% and 8% of builders reported land prices were increasing. Despite rising prices, a majority of builders are moving forward with land acquisition, with 50% moving “full steam ahead” and 47% “cautiously moving forward.”