Homebuilder Blues: Sentiment Hits 12-Month Low Amid Market Uncertainty

Despite the Federal Reserve's easing stance on monetary policy and cooling inflation rates, housing prices are up significantly, sparking an affordability crisis. While mortgage rates have dropped lately, they still hover near record-high levels, causing homebuilders to remain bearish. 

The National Association of Home Builders/Wells Fargo Housing Market Index (HMI) fell by six points to 34 last month, marking the fourth consecutive month of declines. Homebuilder sentiment stands at the lowest level since December 2022 and has plummeted by 22 points over the last five months. 

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Skyrocketing Building Costs 

High inflation rates pushed up construction and financing costs significantly over the past year, causing the housing supply to remain tight. Elevated short-term interest rates have raised the burden on homebuilders and land developers, presenting an additional challenge to housing supply in a market already facing limited resale inventory.

With supply remaining tight, many prospective homebuyers have been priced out of the market, incentivizing homebuilders to lower home prices to stimulate sales. 

In November, 36% of builders planned to reduce home prices, an increase from 32% in the previous two months, according to a survey conducted by the National Association of Home Builders. Incentives were offered by 60% of builders last month to boost sales.  On average, homebuilders slashed housing prices by as much as 6% in November. 

Cautiously Optimistic Outlook 

The Federal Reserve is expected to maintain its dovish policy stance through 2024 as the macroeconomic data signals cooling inflation. The probable decline in inflation rates has driven homebuilders to adopt a cautiously optimistic outlook, as the expected decline in inflation rates will boost demand. 

"While builder sentiment was down again in November, recent macroeconomic data point to improving conditions for home construction in the coming months," said Robert Dietz, chief economist at the National Association of Home Builders (NAHB). "Given the lack of existing home inventory, somewhat lower mortgage rates will price-in housing demand and likely set the stage for improved builder views of market conditions in December."

The NAHB estimates single-family starts to rise by 5% in 2024, as inflation cools. According to a consumer sentiment survey by the University of Michigan, a year outlook on inflation rate stands at 3.1%, marking the lowest forecast since March 2021. The outlook was 4.5% in November. 

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The Federal Reserve's fight against inflation is showing "slow but clear progress," according to Chicago Fed President Austan Goolsbee, as the consumer price index rose by 3.2% year over year in October. 

Given this backdrop, homebuilders are showing cautious optimism because of recent indications that interest rates might decrease soon.

Housing Activity To Pick Up Soon: Morgan Stanley 

Ellen Zentner, chief U.S. economist at Morgan Stanley, predicts homebuilder activity will pick up in the next year, easing the current supply crunch. With easing inventory levels and declining mortgage rates, home prices are expected to drop modestly in the coming months. 

“We expect home sales to be weak in the first half of next year, but activity should pick up in the second half and further into 2025, and that’s primarily because affordability will improve,” Zentner said, “Home prices should see modest declines as growth in inventory offsets the increase in demand. By 2025, with lower rates, existing home sales should rise more convincingly."

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