What Does A Housing Recession Mean For Investors?

Key takeaways

  • According to the National Association of Home Builders (NAHB), homebuilder sentiment has dropped for eight straight months
  • High interest rates and rising construction costs have kickstarted a “housing recession”
  • However, many housing-related companies are still going strong, if the Home Depot earnings release is any indication

Rent is on the rise.

Home prices are staggering.

Mortgage rates can’t decide if they’re up, down, or sideways.

New home construction is on the downswing as the cost of building a home continues to soar, all while the ability to afford one has bottomed out.

Add to that survey results that show plunging homebuilder confidence, and this hasn’t been a great month for the housing market. One might even say that a housing recession is on the horizon.

And yet, somehow, construction-related companies like Home Depot continue to see booming profits and demand.

So, naturally, we have to ask: What gives?

Disappointing news in the housing market

On Tuesday, the Census Bureau dropped some disappointing news.

Housing starts, or homes newly under construction, plunged 9.6% in July. The number of new construction projects totaled just 1.4 million, or 100,000 fewer than expected, while building permit applications fell 1.8% from June levels.

The number of multi-family projects also declined a staggering 10% month-over-month. (Though still 17.4% higher from a year ago’s numbers.) However, multi-family unit permit applications rose 2.8%, suggesting builders are preparing to capitalize on the hot rental market.

In response to the news, home building stocks fell across the board. The SPDR S&P Homebuilders ETF slid 0.5%, while the iShares U.S. Home Construction ETF dropped 0.7%. Meanwhile, D.R. Horton and PulteGroupPHM
both slipped around 1%, while NVRNVR
and LennarLEN
both shed 0.4%.

High inflation prices buyers out

These construction declines coincide with declining homebuyer demand.

During the pandemic, rock-bottom interest rates, increased savings and the work-from-home era sparked a home-buying frenzy. As buyers bid up prices, the housing market boomed…and then boomed some more.

Inflation hit, and the cost of everything from lunch to lumber hit the roof. Home prices soared out of reach as the average price of a brand-new house topped $400,000 for the first time in U.S. history. Meanwhile, the Fed spiked interest rates to address rising inflation, boosting mortgage rates 100% in a year.

This putrescent combination of sky-high home prices, rising mortgage rates and stifling consumer inflation have forced all but the wealthiest or most determined buyers out of a new home. Now, it seems the whole housing market – not just prospective middle-class buyers – are on hiatus until conditions ease up.

NAHB economist: welcome to the “housing recession”

The Census Bureau’s data hit just one day after the National Association of Home Builders (NAHB) reported their latest Sentiment Index readings and survey results.

The NAHB survey gauges housing market conditions by current sales, sales expectations and buyer traffic for the next six months. According to Monday’s report, July marked the eighth straight month of declines in homebuilder sentiments.

The latest reading showed the Sentiment Index falling to 49 for the first time since May 2020. (Any reading under 50 indicates “poor” conditions.) Current sales conditions dropped to 57, while sales expectations slid even lower, to 47. But it was buyer traffic that sealed the deal, plunging to 32 in a “troubling sign that consumers are now sitting on the sidelines due to higher housing costs.”

In a statement, NAHB Chairman Jerry Konter noted: “Ongoing growth in construction costs and high mortgage rates continue to weaken market sentiment for single-family home builders.”

NAHB chief economist Robert Dietz agreed and expounded, stating: “Tighter monetary policy from the Federal Reserve and persistently elevated construction costs have brought on a housing recession.”

Builders seem to concur, with nearly 70% surveyed reporting higher interest rates as the number one factor driving downward demand. And despite rising costs, 19% reported lowering prices an average of 5% to limit cancellations or increase sales.

Housing market experts remain cautiously optimistic

One unique challenge of the current housing markets is our recent economic history.

While interest rates are higher than they’ve been in a decade, that’s not just inflation at play. Over the last ten years, mortgage rates have sat at (relatively) history lows, making the prospect of taking out a loan more attractive.

But as housing prices have risen during the pandemic, the cost of a mortgage has also shot up, increasing the cost of becoming a homeowner on two fronts.

That said, some experts remain cautiously hopeful. Lumber prices have been on the decline recently, and it appears that high rents are incentivizing more builders to construct multi-family units. Some firms are predicting that we’re nearing our peak pullback in the housing market.

Others have taken a dourer approach, such as Fitch Ratings. This firm predicts that in a worst-case scenario, a housing recession could see activity plunge 30% while home prices drop as much as 15%.

Robert Frick, an economist at Navy Federal Credit Union, is less pessimistic. His take: “Once inventories increase more, we should see price increases slow down, and we may even see price drops in some overheated markets. Then home builder and buying can start to improve.”

However, our week isn’t over yet. Thursday, the National Association of Realtors (NAR) is expected to report on last month’s existing home sales. Current predictions expect a fall of about 6% to 5.1 million.

Home Depot earnings contradict housing market data

Soaring mortgage rates, unaffordable home prices and decreased construction activity all spell bad news for the so-called housing recession. But Home Depot’s recent earnings activity tells another story.

In Q2, the home improvement retail behemoth reported record earnings and sales yet again, beating analyst expectations. Revenue soared 6.5% from last year’s numbers to $43.8 billion, totaling a net profit of $5.2 billion. (That translates to per-share earnings of $5.05.) The company also reiterated its full-year earnings outlook with expectations of mid-single digits growth.

Management credit continued strength in home improvement project supplies for its success – but that’s not all.

According to CEO and president Ted Decker, Home Depot’s numbers have seen no “material signs” of housing market weakness, despite recent declines. Management reported strong demand in both DIY and professional contract demographics, with the purchase price of each ticket rising about 9% YOY.

Though certainly not conclusive, that Home Depot’s earnings report showed such strength amid a weakening housing market could suggest that the “housing recession” won’t be as dreadful as it seems. Perhaps, even, a little cool-down could leave enough room for housing to become affordable once more.

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Source: https://www.forbes.com/sites/qai/2022/08/17/what-does-a-housing-recession-mean-for-investors/