Back in September, Fed Chair Jerome Powell told reporters that the U.S. housing market was passing through a “difficult [housing] correction” that would restore “balance” to the market.
At the time, new-home sales and existing home sales were falling fast as spiked mortgage rates created a buyer affordability shock. Things were even worse in Western housing markets, like Reno and Boise, where they had not only slipped into a housing recession—a sharp pullback in activity levels—but also full-blown home price corrections.
Fast-forward to June 2023, and that so-called housing recession and housing correction looks long gone as resurgent 2023 buyer demand has translated into an uptick in everything from national home prices to new-home sales. Even Powell thinks the bottom is in.
“We now see housing putting in a bottom, and maybe moving up a bit. We’re watching that situation carefully. I do think we’ll see rents and house prices filtering into housing services inflation [overall housing costs as tracked by the consumer price index], and I don’t see them coming up quickly. I see them wandering around at a low level,” Powell told reporters earlier this month.
Are we in the early innings of a housing recovery? Does downside risk still remain?
To better understand what’s going on in the housing market, Fortune reached out to Zonda chief economist Ali Wolf. When she’s not traveling around the country speaking to homebuilders, she’s advising the White House on housing matters.
Below is Fortune’s Q&A with Ali Wolf.
Fortune: Homebuilders have seen a significant improvement this spring. New-home sales are rising, and resale, or existing, inventory remains tight. Do builders expect the worst is behind them?
It’s important to talk about where we are coming from to talk about where we are. Demand last year in many markets across the country slowed, with some markets feeling the cooling as early as March 2022 and others not until October or November. During the period, quick move-in home inventory—new homes that can be moved into within 90 days—started to build up. This made builders nervous that we had found the end of the housing market cycle, and they started to offer discounts and incentives to help move the product. At the same time, many made a decision to stop building more quick move-ins as standing inventory can be a liability when the market slows.
What’s interesting is that we saw price elasticity play out in real time. Consumers returned to the market on the lower prices and incentives. This matched our consumer survey data at Zonda that showed the number one reason renters were renting was because they were “waiting for prices to come down.”
The uptick in demand changed sentiment about the market. Instead of thinking the housing market was crashing, people started to see that there were deals available, which helped encourage those on the sidelines to reenter the market. The housing market in 2023 so far has far exceeded expectations.
Builder sentiment has turned positive again. Builders are starting more homes and are enthusiastic about the demand pool. I’d say most are using the phrase “cautiously optimistic” [regarding] what the future holds. Some are still nervous about broader macro considerations, but many feel good that housing demand has held up despite 6.5% to 7.0% interest rates.
It looks like mortgage rate buydowns, in particular, have helped builders “find the market” this spring. Given the sales improvement, could builders soon pull back on buydowns or incentives?
Since the middle of last year, the majority of new-home communities have been offering incentives to help sweeten the deal for consumers. These incentives range from help with closing costs to funds for options and upgrades and flex dollars. The most effective incentive when it comes to housing affordability, though, is what is known as a mortgage rate buydown.
Builder-funded mortgage rate buydowns come in two forms. Option one: Builders can offer an adjustable-rate mortgage. This is one where the builder offers the consumer a mortgage with a low interest rate in the first year that progressively goes higher over typically three to five years. Unlike last cycle, the consumer has to qualify for the higher rates so poses less of a systemic risk to the wider economy. Option two: Builders can offer a 30-year fixed rate buydown. This is more costly to the builder but ensures that the monthly payment is fixed for the consumer over the life of the loan.
Active home shoppers don’t typically go into a new-home community knowing the jargon and understanding the impact of mortgage rate buydowns, but learn from the sales team what it means for their monthly mortgage payment.
The significance of mortgage rate buydowns in today’s housing market cannot be overstated. Buydowns have addressed the key issue in the housing market today—housing affordability. The buydowns have also been a key selling point from the new-home community compared to existing homes. We don’t believe mortgage rate buydowns will stay in the market indefinitely, though, especially if builder margins get compressed and/or sales stay solid.
With higher sales so far this year, builders have been less generous with incentives than in the past. At the end of last year, incentives were almost guaranteed. Today, we are seeing incentives being offered more on a case-by-case basis.
After falling for seven straight months, U.S. home prices as measured by the seasonally adjusted Case-Shiller National Home Price Index rose in February and March. Does that mean that U.S. home prices have bottomed—or do downside risks still remain? Where do you see house prices heading from here?
Objectively, the housing recession in the new-home space is over. Home sales are rising, starts are rising, and home prices are rising again. The big question is—is that it? Are we back in growth mode from here? I’m not so sure it is a straight line up. There are still broader economic concerns that could impact housing demand, including potential turmoil following the Federal Reserve’s restrictive policy, a significant pullback in consumer spending, or even the fallout from the commercial real estate sector. We are watching closely to see if there’s a double-dip recession in housing or if demographic-supported demand is enough to withstand wider issues.
How do you expect seasonality to impact this housing market in the second half of 2023?
There are already signs in our data that normal seasonality is kicking in. For the new-home market, February to May are traditionally the strongest months of the year. The lack of resale competition may buoy the new-home market a bit more than normal, though.
Western markets like Austin and Reno have seen home prices fall a bit over the past year. While many Midwestern and Northeastern markets are still rising despite the mortgage rate shock. Why does the market feel so bifurcated right now? And should we expect stark regional trends to continue?
We’ve spent a lot of time trying to explain the regional differences, and the big thing that stands out to us is the difference between payment-to-income ratios across the country. Parts of the West already had stretched payment-to-income ratios before the pandemic, meaning homebuyers were already putting a sizable amount of their income towards housing each month. The ratios were way healthier in the Midwest and Southeast. As home prices rose, the stretched markets found themselves reaching new levels that were hard for many consumers to overcome. The resulting impact was the home price correction to better align fundamentals. The Midwest and Southeast still offer relative affordability, especially to those that have relocated to these markets. We suspect given the differences in affordability, employment, and migration, there will continue to be regional variation in housing performance.
