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Tag: fed housing reset

  • The Fed’s ongoing housing market ‘reset’ sees buyer cancellation rate at one of the nation’s largest homebuilders spike to 68%

    The Fed’s ongoing housing market ‘reset’ sees buyer cancellation rate at one of the nation’s largest homebuilders spike to 68%

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    “When I say reset, I’m not looking at a particular specific set of data. What I’m really saying is that we’ve had a time of a red-hot housing market all over the country, where famously houses were selling to the first buyer at 10% above the ask even before seeing the house… For the longer term what we need is supply and demand to get better aligned so that housing prices go up at a reasonable level and at a reasonable pace and that people can afford houses again. We probably in the housing market have to go through a correction to get back to that place,” Powell said. “But from a business cycle standpoint, this difficult [housing] correction should put the housing market back into better balance.”

    Of course, this so-called “difficult [housing] correction” has already arrived. Look no further than the latest earnings report by KB Home, one of the nation’s largest publicly traded homebuilders.

    On Wednesday, KB Home announced that its buyer cancellation rate in the fourth quarter of 2022 spiked to 68%. That’s up from 35% in the third quarter of 2022, and up from 13% in the fourth quarter of 2021.

    “Current conditions remain challenging. High mortgage rates and persistent inflation, together with an uncertain economy, have made homebuyers more cautious since the middle of last year. As such, in the fourth quarter, we prioritized delivering our large backlog and protecting our high margins over taking steps to stimulate additional sales during this seasonally slower time frame,” KB Home told investors on Wednesday.

    Historically speaking, a 68% cancellation rate is off the charts. Even during the darkest days of the 2008 era crash, the average builder cancellation rate only reached 47%.

    What’s going on? Pressurized affordability—a 3 percentage point mortgage rate jump following a +40% run-up in U.S. home prices—has sent a shock wave through the U.S. housing market. Some buyers are cancelling their contracts because they’re afraid that home prices will fall further in 2023; others have simply lost their mortgage eligibility in the face of 6% mortgage rates.

    Spiking cancellation rates puts homebuilders in a pickle. The problem: builders still have a tremendous amount of inventory—both single-family and multi-family—in the pipeline. The pandemic housing demand boom coupled with supply chain issues pushed the number of U.S. housing units under construction to a record high in 2022.

    Heading forward, builders will continue to turn to their housing downturn playbook to unwind that unsold inventory. They’ll start by offering incentives like mortgage rate buydowns, and if that doesn’t work, then begin to mark down home prices until their unsold inventory has been moved.

    “Depending on market dynamics and backlog levels in each community, we are getting more aggressive with our pricing ahead of the spring selling season, in order to generate new orders. At the same time, with the industry-wide deceleration in housing starts compared to a year ago, we are also pursuing reductions in direct construction costs and build times, which should help to offset the impact of pricing adjustments we may take,” KB Home told investors on Wednesday.

    When it comes to cutting home prices, KB Home is treading lightly. If word gets out, buyers already under contract could get frustrated and cancel their contracts. That reason, coupled with wanting to protect their “comps”, is why builders prefer to offer incentives like mortgage rate buydowns rather than cut prices too much.

    Real estate agents and builders alike are rooting for a loosening of financial conditions, and a subsequent drop in mortgage rates.

    If mortgage rates fall on, say, favorable news on the inflation front, then affordability could gradually return to the market. Otherwise, as long as affordability remains “pressurized,” the U.S. housing market will likely remain in “reset” mode.

    Researchers at firms like Goldman Sachs and Moody’s Analytics aren’t as optimistic when it comes to mortgage rates. Both firms expect mortgage rates to hover around 6% this year, and both firms expect U.S. home prices to continue to fall through 2024.

    While the Fed’s housing “reset” certainly has builders reeling, it’s hardly a doomsday for them. Just look at the stock market.

    While major homebuilders are all down from their 2022 highs, they’re still well above their January 2020 share price. That includes builders like D.R. Horton (+78% since January 1, 2020 ), Lennar (+73%), Toll Brothers (+34.5%), NVR (+29.3%), PulteGroup (+25.2%), and KB Home (+1%).

    Bank of America researchers think the bottom in homebuilder stocks could be in the rearview mirror.

    “Homebuilder stocks underperformed in 2022 as mortgage rates spiked to 7% from 3% and demand deteriorated in the second half of the year. In 2023, we are cautious on housing demand…but we see a more favorable setup for homebuilder stock performance for a few reasons: 1. Homebuilder valuations are already pricing in weak demand and home price depreciation. 2. Mortgage rates have declined from peak levels and are poised to move lower in 2023. 3. We do not see material risk to book value – most of the land on balance sheets was purchased prior to 2021 and we expect a home price correction (down 10%) rather than a crash (down 15-20%). 4. Builder margins will benefit from lower input costs (estimate 200-300 basis points tailwind from lumber),” Bank of America researchers wrote on Wednesday.

    Bank of America reiterates a neutral rating for KB Home.

    “We expect [KB Home] orders to remain under pressure with rising mortgage rates, but headwinds are likely already reflected in valuation with shares trading,” wrote Bank of America researchers. “In addition, we believe KBH has some cushion to its margins even as pricing declines given 40% [of] its owned lots were contracted in 2019 and another 40% were contracted in 2020, prior to the run-up in land prices. Still, we believe KBH has the highest risk of write-downs across our coverage given its high exposure to underperforming West Coast [and] Mountain [West] markets.”

    Want to stay updated on the housing correction? Follow me on Twitter at @NewsLambert.

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    Lance Lambert

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  • The Fed’s housing market ‘reset’ isn’t letting up anytime soon—5 things to know heading into 2023

    The Fed’s housing market ‘reset’ isn’t letting up anytime soon—5 things to know heading into 2023

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    “We have a ways to go, we have ground to cover with interest rates before we get to that level of interest rates that is sufficiently restrictive…we will stay the course until the job is done,” Powell told reporters after unveiling the Fed’s fourth consecutive three-quarter point hike in the Federal Funds rate.

    That’s not exactly what builders and mortgage brokers were hoping to hear.

    On one hand, this latest hike shouldn’t send mortgage rates—which financial markets price ahead of anticipated shifts in financial conditions—spiking. On the other hand, this additional rate hike also means financial markets aren’t about to send mortgage rates plunging.

    During the presser, Powell acknowledged that continued quantitative tightening means more pain still awaits the U.S. housing market.

    “Housing is significantly affected by these higher rates,” Powell told reporters. “The housing market needs to get back into a balance between supply and demand. We’re well aware of what’s going on there.”

    What exactly does that mean?

    To get a better idea of where the housing market downturn might head in 2023, let’s take a deeper dive into recent Fed commentary. Here’s the five big takeaways.

    1. The Fed’s housing market “reset” has pushed us into a “difficult [housing] correction”

    In June, Powell told reporters that the U.S. housing market needed to be “reset.”

    “We saw [home] prices moving up very, very strongly for the last couple of years. So that changes now…I’d say if you are a homebuyer, somebody or a young person looking to buy a home, you need a bit of a reset. We need to get back to a place where supply and demand are back together and where inflation is down low again, and mortgage rates are low again,” Powell told reporters this summer.

    At the time, Powell admitted he wasn’t sure how the “reset” would impact home prices. However, fast-forward to the September meeting, and Powell acknowledged that the Fed’s policy moves had pushed the U.S. housing market into a “difficult correction.”

    According to Moody’s Analytics chief economist Mark Zandi, a housing correction is a period in which the U.S. housing market—which got priced to 3% mortgage rates—works toward equilibrium in the face of spiked rates. Unlike the stock market, housing corrections are felt most acutely through a sharp drop in home sales. That said, Zandi says this correction will also put downward pressure on home prices.

    2. U.S. home prices are falling for the first time since 2012—the Fed says it could turn into a “material” drop

    In June, Powell said he was “not sure” if spiked mortgage rates would translate into lower home prices. But on Wednesday, Powell said “in some parts of the country you’re [now] seeing house prices declining.”

    The data backs him up. The latest reading of the Case-Shiller National Home Price Index shows that U.S. home prices fell 1.3% between June and August. That’s the first decline nationally since 2012.

    “While this [housing] market correction could be fairly mild, I cannot dismiss the possibility of a much larger drop in demand and house prices before the market normalizes,” Fed Governor Christopher Waller told an audience at the University of Kentucky in October.

    Waller went on to say this could turn into a “material” home price decline.

    Just how big is a “material” correction? Waller didn’t elaborate.

    3. The pandemic’s demand boom is over

    Even as policymakers scrambled to save an economy with a double-digit jobless rate in the spring of 2020, the U.S. housing market was already moving into boom mode.

    That boom was set-off by a spike in housing demand. Wealthy urbanities wanted second homes to help them escape locked down cities. Remote workers realized they could finally move deeper in the burbs or take off for a more affordable market. Meanwhile, investors realized that a combination of home price appreciation and historically low mortgage rates meant they could make a killing in the housing market.

    “We show that the COVID-19 housing boom in the U.S. was driven by an increase in demand…Since new construction typically accounts for about 15% of supply, our estimates imply that new construction would have had to increase by roughly 300% to absorb the pandemic-era surge in demand,” wrote Fed researchers this summer.

    That’s all over now. In the face of soaring mortgage rates, that demand boom deflated. Second home purchases tanked. Flippers called timeout. And some would-be buyers got called back into the office.

    This historic demand pullback could help the housing market achieve Powell’s goal of “balance.” By temporarily sidelining buyers, the Fed can give inventory breathing room to adjust upwards.

    4. The U.S. mortgage backed securities market remains “broken”

    Anytime the Fed moves into inflation-fighting mode, mortgage rates rise.

    That said, the magnitude of the mortgage rate gains— rates jumped from 3.09% to 7.3% over the past year—has caught the industry off guard. Historically, mortgage rates trade around 1.75 percentage points above the 10-year Treasury yield (which is currently at 4%). That spread is around 3 percentage points right now. The reason? As the Fed backed off buying mortgage-backed securities, investors—who assume new borrowers will refinance in the future and thus reduce returns—weren’t eager to pick up the MBS securities.

    This divergence between Treasury yields and mortgage rates has some analysts claiming the “MBS market is broken.”

    While the Fed hasn’t publicly commented on the spread, Powell did say in June he expects mortgage rates to eventually fall. What could cause that? If the Fed successfully tames inflation, it could pull back on hikes. There’s also the chance that higher rates could push us into a recession, which would then prompt the Fed to lower rates.

    5. A “material” drop in home prices shouldn’t set off a 2008-like financial crisis

    Unlike the housing correction that started in 2006, Powell doesn’t expect the 2022 correction to trigger a financial collapse.

    “From a financial stability standpoint, we didn’t see in this cycle the kinds of poor underwriting credit that we saw before the Great Financial Crisis. Housing credit was much more carefully managed by the lenders. It’s a very different situation [in 2022], it doesn’t present potential, [well] it doesn’t appear to present financial stability issues. But we do understand that [housing] is where a very big effect of our policies is,” Powell said on Wednesday.

    Fed Governor Waller had a similar message back in October.

    “Despite the risk of a material correction in house prices, several factors help reduce my concern that such a correction would trigger a wave of mortgage defaults and potentially destabilize the financial system,” Waller told an audience at the University of Kentucky. “One is that because of relatively tight mortgage underwriting in the 2010s, the credit scores of mortgage borrowers today are generally higher than they were prior to that last housing correction. Also, the experience of the last correction taught us that most borrowers only default when they experience a negative shock to their incomes in addition to being underwater on their mortgage.”

    Want to stay updated on the housing correction? Follow me on Twitter at @NewsLambert.

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    Lance Lambert

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