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Tag: housing correction

  • 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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  • Intensified housing market correction has homebuilders offering sweetheart deals to Wall Street

    Intensified housing market correction has homebuilders offering sweetheart deals to Wall Street

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    Homebuilders have a housing downturn playbook that’s proven to be effective time and again. They start by offering incentives like mortgage rate buydowns. If that doesn’t work, then builders begin to mark down home prices communities until their unsold inventory has been moved.

    Fast-forward to 2022, and homebuilders have clearly returned to their housing downturn playbook, only there’s a new wrinkle: institutional investors. In the years following the 2000s housing bust, institutional investors like Blackstone saw an opportunity to buy more directly from distressed builders. The expansion in this so-called “build-to-rent” category means that builders, this time around, are already floating big-time markdowns to Wall Street buyers.

    Last week, Bloomberg reported that homebuilding giant Lennar would begin to shop 5,000 unsold properties—an amount greater than the entire total active inventory in Kansas City—to institutional investors. In some of these Southwest and Southeast communities, investors would have the opportunity to buy entire subdivisions at a discount.

    “What’s an interesting dynamic with the institutional investors is a lot of them have been sitting on the sidelines waiting for that moment to strike… [they’re thinking] ‘Hey, I want to buy these homes from you [the builder], but I want to have a discount to do so.’” Ali Wolf, chief economist at Zonda tells Fortune.

    These institutional investors don’t just want markdowns in the 10% ballpark, they’re hoping for “20% and 30%” price cuts, says Wolf.

    On one hand, the current average 30-year fixed mortgage rate (6.28%) means the housing market downturn is still very much alive. On the other hand, the decline in the average 30-year fixed mortgage (down from 7.3% in early October) means the bottom for housing demand might be in the rearview mirror. That’s why, Wolf says, some institutional investors might be ready to pull the trigger.

    “What we’re hearing now is that some investors, because mortgage rates have come down, they’re afraid that primary buyers are going to come back into the market. So some of the institutional buyers are trying to rush in now because they’re afraid that there will be a pop in demand from primary buyers and they’re going to lose their opportunity,” Wolf says.

    Why are homebuilders like Lennar going to investors now? There are two big reasons.

    First, the ongoing housing correction has sharpened in recent months. As mortgage rates floated around 7% in October, the homebuilder cancellation rate (i.e. the percentage of buyers who back out of their contract) tracked by John Burns Real Estate Consulting spiked to 26%. That elevated cancellation rate—coupled with a weak 2023 spring housing market on the horizon—means builders are discounting faster and making sweeter deals to investors who can buy in bulk.

    Second, homebuilders still have a tremendous amount of inventory—both single-family and multi-family—in the pipeline. A pandemic housing demand boom coupled with supply chain issues pushed the number of U.S. housing units under construction to a record high this year. Now, with cancellation rates spiking, builders are eager to get this backlog sold before they finish construction.

    In the future, Wolf expects the historic pipeline of unfinished homes to continue to depress new home prices through the first half of 2023. But once standing inventory has been cleared and the pipeline is under control, the pressure on new home prices should ease up.

    Just how many of these homes will go to institutional investors? It’s hard to say.

    While firms like Blackstone have made it clear they’d like to continue to grow their real estate portfolios, some institutional buyers have also temporarily moved to the sidelines in the face of the ongoing housing correction. Look no further than Blackstone-owned Home Partners of America, one of the nation’s largest private landlords, which announced in August that it would halt single-family home purchases in 38 U.S. regional housing markets.

    There’s also the fact that firms like Blackstone and Starwood announced plans earlier this month to limit withdrawals from their real estate funds. It’s unclear how the ongoing surge in redemption requests from investors will affect their plans for future real estate investments.

    While the housing downturn certainly has homebuilders scrambling to move standing inventory, it doesn’t mean we should pencil in doomsday for builders.

    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 (+72.9% since January 1, 2020 ), Lennar (+67.4%), Toll Brothers (+30.2%), NVR (+28.5%), and PulteGroup (+21.8%). During the same period, the S&P 500 Index rose 22.5%.

    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 U.S. housing market to see second biggest correction of the post-WWII era—when to expect the home price bottom

    The U.S. housing market to see second biggest correction of the post-WWII era—when to expect the home price bottom

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    Homebuilders and economists alike saw the 2000s housing bubble brewing—they just didn’t think it would burst. Their reasoning being, that at the time, home prices hadn’t really fallen since the Great Depression era.

    “I think that the religion people had from 1946 to 2008, that housing prices always go up, is dead. My parents believed that it was literally inconceivable for [home] prices to go down,” Redfin CEO Glenn Kelman tells Fortune.

    That “religion” of course came crashing down after the bursting housing bubble caused U.S. home prices to fall a staggering 27% from 2006 to 2012. Knowing that home prices can indeed fall, Kelman says, is why builders and flippers started cutting prices faster this time around. Once the market shifted, they wanted to get out first.

    “Folks [are] responding [in 2022] to that with almost PTSD, and they pull back much more quickly,” Kelman says.

    As of August, the lagged Case-Shiller Index showed that U.S. home prices had fallen 1.3% from their June 2022 peak. That marks the first decline since 2012. It’s also likely well below the actual drop. Just look at the 7.6% decline in third quarter U.S. home equity, as reported on Friday by Black Knight. That’s the biggest home equity drop ($1.3 trillion) ever recorded, and the biggest percentage drop since 2009.

    Just how far will home prices fall? It depends on who you ask.

    Researchers at Goldman Sachs expect U.S. home prices to decline between 5% to 10% from peak-to-trough—with their official forecast model predicting a 7.6% drop. If it comes to fruition, it’d surpass the 2.2% decline between May 1990 and April 1991. That would make this ongoing correction the second biggest home price decline of the post-World War II era.

    “Economists at Goldman Sachs Research say there are risks that housing markets could decline more than their model suggests…based on signals from home price momentum and housing affordability,” writes Goldman Sachs on its website.

    That said, it could take a while for home prices to reach the bottom. In fact, the Goldman Sachs model estimates U.S. home prices won’t get to that point until March 2024.

    Researchers at Moody’s Analytics are a bit more bearish.

    It forecasts a 10% peak-to-trough U.S. home price decline, with prices bottoming out in late 2025. However, if a recession hits, Moody’s Analytics would expect a bigger 15% to 20% peak-to-trough decline.

    Of course, when groups say “U.S. house prices,” they’re talking about a national aggregate. Regionally, researchers acknowledge that shifts in home prices vary significantly by market. In bubbly markets like Boise and Nashville, Moody’s forecasts a decline of around 20%. Meanwhile in Chicago, a relatively tame market during the boom, it expects a home price decline of less than 3.6%. (You can find their forecast for 322 markets here).

    Why are home prices already starting to roll over? It boils down to what Fortune calls pressurized affordability. Spiked mortgage rates coupled with a historic 43% jump in U.S. home prices during the Pandemic Housing Boom has simply put monthly payments beyond what many would-be borrowers can afford.

    When it’s all said and done, Moody’s Analytics chief economist Mark Zandi thinks this ongoing housing correction will push national housing fundamentals back in line with historic norms.

    “Before prices began to decline, we were overvalued [nationally] by around 25%. Now, this means prices will normalize. Affordability will be restored. The [housing] market won’t be overvalued after this process is over,” Zandi says.

    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 home price correction intensifies—what to expect from the U.S. housing market in 2023

    The home price correction intensifies—what to expect from the U.S. housing market in 2023

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    That, of course, is what we’re seeing now. Despite favorable demographics and tight inventory levels, pressured affordability—spiked mortgage rates coupled with frothy home prices—is beginning to push home prices lower. In fact, this week we learned that U.S. home prices as measured by the Case-Shiller U.S. National Home Price Index posted its first month-over-month decline since 2012.

    Across the country, the U.S. housing market—which got priced to 3% mortgage rates during the Pandemic Housing Boom—is working toward equilibrium in the face of 6% mortgage rates. But we’re still in the early innings. And the ongoing home price correction still hasn’t hit every market: Between May and August, home values in San Jose fell 10.6% while home values grew 2% in Orlando.

    To better understand where the U.S. housing downturn heads next—and if the home price correction will soon hit more markets—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: As the data rolls in, it’s pretty clear that home prices are falling in many markets across the country. In some places it’s fairly sharp. Do you expect home price declines to continue into 2023?

    Wolf: We haven’t seen home prices drop universally across the country, but there are some markets where home prices have started to come down and we expect to see that in more metros across the country in the next handful of months. Corrections in home prices can be expected in 2023 as long as interest rates remain elevated and consumer demand remains slow.

    What types of markets are the most vulnerable? 

    The markets that are the most vulnerable include: 1) Those where home prices rose sharply because of hybrid work, like Boise, Las Vegas, and Denver. 2) Markets that don’t have a local employment base to support the higher home prices (put another way, markets where home prices and incomes are out of whack), like Nashville and parts of Florida. 3) Markets where housing inventory has risen rapidly, like Phoenix and Austin.

    Why are markets like Austin, Boise, and Phoenix shifting so fast? 

    The housing booms seen in markets like Austin, Boise, and Phoenix were among the earliest in the nation and the sharpest. The record-low mortgage interest rates combined with lifestyle changes brought on by the pandemic, including work from home and increased relocations, drove a dramatic uptick in housing demand and supply could not keep pace.

    Those relocating from places like California and Washington were able to tap home equity from a sale in the higher cost market and put those funds towards buying a new home in these relatively more affordable markets. Relocation buyers found these markets very affordable compared to where they were moving from at the detriment of local buyers.

    There was a belief in these markets that the supply and demand imbalance was so severe and so long standing that the markets could never get overheated. Buyers, frantic to secure a home, were willing to pay almost any price to secure a home. Investors and flippers considered these markets ripe for opportunities. This mentality contributed to the massive run-up in home prices.

    As interest rates rose in early 2022, however, reality started to kick in. Home price appreciation was slowing and not every home that was listed was selling for above the list price within a day of coming online. The demand for housing slowed just as some of the new homes under construction started coming online and existing home inventory rapidly increased as sellers tried to time what they believed to be the top of the market. 

    How do you expect mortgage rates near 7% to impact the housing market? We were already correcting with 5% mortgage rates. Should we expect things to intensify with 6.5%-7% rates?

    Housing affordability is driven by many factors, but the two key inputs are home prices and mortgage rates. We just lived through a unique period in American history where rising home prices were offset by record-low interest rates. The cheap financing helped keep the monthly mortgage payment in check.

    Interest rates have risen dramatically since the start of the year, though, putting a strain on housing affordability. Buyers were already starting to get priced out of the market when interest rates moved from 3% to 4% and every 100-basis point increase has continued to price millions of Americans out of homeownership.

    If mortgage rates remain elevated for an extended period, we expect that housing demand will remain soft, new home construction will be restricted, and home prices will need to adjust downward across the country.

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

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    Lance Lambert

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