While inflation has begun to cool, it still remains up between 6% and 8% compared with last year, and the overall economy has not yet returned to a more healthy level. During Zonda’s most recent Housing Market Update, chief economist Ali Wolf says that Zonda’s expectation is the economy falls into a recession, which includes job losses on a national basis, in 2023.
“While we do have inflation numbers that look a little bit better, the Federal Reserve governors don’t want our financial markets to just fully rebound that quickly because from the Federal Reserve’s point of view, we still have a long way to go until we’re at a point where the economy is back under control and back to something that is more healthy,” Wolf says.
While overall inflation is beginning to cool, several major components of inflation—including basic living expenses such as transportation, food and beverage, and housing—have high year-over-year inflation levels. Housing accounts for a large share of inflation data, and inflation in the sector remains 8% higher on a year-over-year basis. While data suggests rent growth is beginning to soften on a month-over-month basis, Wolf says the shelter component in inflation usually lags changes in the for-sale housing market by about a year.
“If we want the Federal Reserve to say ‘we need to stop,’ they’re not going to until we see this overall level [of the shelter component] come down,” Wolf says. “Going into the first and second quarter of next year, we may still be reevaluating [the shelter inflation component] numbers and rechecking to see if we’re seeing enough of a cooling effect.”
While inflation cooling may put downward pressure on the 10-year treasury and mortgage rates, affordability will still remain a top concern in the housing market. Wolf says the combination of home price appreciation and rising mortgage rates have contributed to the average national monthly payment increasing 80% since the beginning of the year. Even if there is relief in mortgage rates, a 5% mortgage rate would still result in a 45% increase in the average monthly payment since the beginning of the year.
“Ultimately, when you look at the fundamental problem, it’s saying that affordability still is going to be an issue with 6% rates, just not as dramatic as what we saw with 7% rates,” Wolf says.
A period of rate declines, related to harder economic times and a potential recession, may not ease affordability due to expected job losses. Based on historical precedents from previous recessions, jobs numbers are likely to remain down between six and 24 months, while the unemployment rate typically rises 1.6% six months after the official start of a recession and 2 percentage points after 18 months.
“The Federal Reserve would rather see the unemployment rate go up—they said they could tolerate a rate in the 5s versus in the 3s because getting inflation under control is issue number one,” Wolf says. “Not getting [inflation] under control is more disastrous than seeing the unemployment rate rise from 3% to 5%.”
Sales vs. Historical Performance
Existing home sales are at their lowest levels since 2012. The decline in sales is not solely inventory related, as 2020 and 2021 both had lower inventory numbers but a higher number of overall transactions. Wolf says the decline in existing sales is a combination of the supply picture and buyers responding to affordability and overall confidence. Supply and demand factors are also contributing to the contraction of sales for new homes, which are at their lowest levels since 2016, according to Zonda data. Some markets, including Miami, Los Angeles, and Boston, have remained more steady in terms of overall new sales volume and are performing at levels comparable with 2019, while markets such as Las Vegas, Phoenix, Dallas, San Antonio, Denver, and Florida's Orlando, Jacksonville, and Tampa are performing at levels comparable with 2016 or earlier. When analyzing markets based on average sales rate compared with historical averages, Denver; Las Vegas; Austin, Texas; Phoenix; and Riverside, California, are also performing at levels comparable with 2016 or earlier.
While there are regional differences, Wolf says the Eastern part of the U.S. “continues to outperform” the Western part of the country. Markets in the Mountain, Southwest, and West, which have become the slowest markets nationally, have seen the payment-to-income ratio become the most imbalanced, Wolf says. Markets that have experienced high levels of price appreciation, migration, and job growth have seen potential buyers “pushed to their limits,” Wolf says.
Real-Time Housing Stats: Price Cuts and High Cancellation Rates
According to Zonda’s most recent division president survey, 81% of builders said they are anticipating pulling back housing starts either significantly or slightly in response to the market, while almost 90% reported anticipating slowing housing starts in 2023. According to the survey, 40% of builders said it takes between eight to 10 months to take a home from start through completion, a sign of supply chain improvement as a majority of builders reported 15 months or more a year ago. Related to slowing starts, Zonda senior managing principal Tim Sullivan says many builders remain “cautious” about their land strategy moving forward.
“Most builders are pausing on deals in the outskirts, but when it comes to the core markets they’re in, they’re paying attention. But, there’s still a concern that land prices are way too sticky, and there needs to be a restructuring of deals,” Sullivan says.
While many builders reported price increases as recently as August 2021 and January 2022, 40% of builders in November reported lowering prices. Sullivan says price drops are most common in the Southwest and West regions, while price drops are least prevalent in the Northeast region.
“The smaller [price] cuts really didn’t get the consumers’ attention, whereas a 7% or 10% cut automatically gets attention from a consumer. We found that in almost every single market,” Sullivan says.
The cancellation rate for builders on a national level was above 20% in October, according to Zonda. In addition to experiencing the largest amount of pricing adjustments, builders in the Southwest and the West also reported the highest levels of cancellation rates, Sullivan says. Cancellations are most prevalent with interest-rate sensitive buyers in the entry-level and move-up segments, while cancellations are lowest among investors and luxury buyers, typically all-cash buyers less sensitive to interest rates. As recently as June, less than 30% of builders reported it was difficult to resell a home after a cancellation; however, 53% of builders in November reported difficulty reselling homes after a cancellation.