As some experts point to an inevitable recession, we take a look at some of the main indicators that suggest what could soon be a possible downturn in the residential construction industry.
How have you been feeling about the economy lately? Economists and policymakers in the US worry that we are about to enter a recession, if we arent in one already today. In fact, there are 5 key indicators from the home construction industry currently flashing red, suggesting that we are headed into a prolonged economic downturn.
One of the easiest ways to forecast economic downturns is to ask people in certain market segments how they are feeling. The Housing Market Index (HMI) is a monthly survey sent out to home builders around the country. It asks them to rate market conditions for single family home sales today, how they believe the market will move in the next six months, and how many prospective buyers theyre seeing enter the market. Answers from the monthly survey are compiled into a confidence score, which can then be tracked across time. And theres been a steady downward trend in homebuilder sentiment for the last eight months, dropping from a score of 83 in January to 49 in August. In other words, homebuilders are self-reporting their own growing pessimism about the housing market. And if new construction slows down, that puts further strain on the supply of houses, and could drive up costs even more. This is a very clear signal from the people who make their money from building homes that we are in or about to enter a housing downturn.
The price for a new home has also exploded over the last two years, another key indicator for a market primed for a downturn. According to data from Redfin, the median sale price for a home reached an all-time average high of $428K in May 2022, which represents a 57.4% increase from January 2019. The data presents a clear pattern, where prices skyrocket during the prime spring buying season, then level off or even retreat slightly for the rest of the year. And now, buyers are starting to get priced out of the market, suggesting that it is one of the biggest issues facing the industry, leading to a lack of sales.
In addition to high house prices, mortgage rates have also shot up over the last eight months. At the start of the year, a 30-year fixed rate mortgage would see an average interest rate of 3.72%. Rates hit their peak in June 2022 at 5.81% before coming back down to 5.22% in August, still significantly higher than where they started the year. When interest rates move upward, it increases the monthly payment required to pay for a house. Suddenly, the same mortgage is about one-third more expensive each month, which also adds up over the years.
What does the combination of higher house prices and higher mortgage rates mean for the construction industry? Housing starts declined in July 2022 by -9.6% from the previous month, meaning that few people are signing up for new home construction. Completions remained relatively steady, increasing by 1.1% from June to July, but these were homes already in the works from several months earlier. Taking a more forward-looking view, permits for new single family houses are down 4.3% from June to July. Once the current pipeline of houses under construction starts to clear, there simply isnt enough demand in the market to sustain the construction industry.
And finally, the costs to build a new home are also going up. From concrete to lumber and other materials, the raw inputs to home construction all show increases in prices with the onset of the COVID-19 pandemic. Higher building material costs only drive up the price of the finished home, pushing buyers out of the market. And although the demand for new houses is starting to decrease, we have yet to see a corresponding decrease in material costs.
Testing times could be on their way for many companies. Yet after the last few years, we have seen that the construction industry is a resilient one. Home builders may be self-reporting their pessimism about the future and see fewer new buyers entering the market, but they are wise to be prepared for a possible downturn. The combination of all the indicators suggest a market correction could be well underway, with the demand for housing starting to evaporate.
But how will this impact the broader US economy? Homeownership remains one of the key ways Americans accumulate wealth. A severe downturn in the housing market would have broader implications than just the construction and real estate industries, and whether that will be the case is by no means conclusive.