The home building industry is cyclical and somewhat predictable. History has proven ups are eventually followed by downs, and downs are eventually followed by ups. The challenge lies in figuring out just when those changes will occur. Right now, the big questions on everyone’s mind, especially builders, include “are we approaching the next down?” and “is now the time to panic?”
In simple terms, the answer is no. There are signs we monitor that suggest the demand frenzy experienced at the onset of the pandemic is settling down to normal, but there is no need to panic at the moment. My advice is to ignore those negative headlines and rely on our housing experts across the U.S. to break down market fundamentals and decipher trends. Here are a few fundamentals and trends I am monitoring in the Midwest along with their breakdown.
Signs suggesting return-to-normal market conditions and demand include:
- Seasonality is back. Throughout most of 2020 and early 2021, seasonality in online and foot traffic by potential home buyers was largely missing. As spring gave way to summer, traffic eased given vacations and the start of a new school year. A slowdown in traffic is typical for that time of year. Early indications suggest fall is bringing a natural increase in traffic.
- Builders are once again incentivizing potential new-home buyers. Offering incentives to potential home buyers to purchase or close on a new home mostly disappeared last year given such strong demand for the limited inventory available. As demand is coming off that frenzy and settling to normal, we are once again observing the use of incentives by some builders.
- Realtor activity has eased since last year’s highs. Real estate showings are well off the highs experienced in 2020 and normalizing to 2019 trends, according to Zillow Group’s ShowingTime tool for the majority of Midwest states.
- Months of supply in the existing home market is on the rise. Inventory has slowly increased over the last several months in most markets as it has improved from trough, but months of supply remains well below the balanced norm of approximately four months.
- Average sale-to-list ratios are decreasing, according to Redfin in the majority of Midwest markets. Given limited supply and bidding wars, homes were selling at above list price, meaning at a ratio greater than 1. While ratios remain largely favorable, they are on the decline and trending toward market norms.
Builders have no need to panic at the moment given:
- This is not a repeat of the Great Recession. For us old-timers in the industry, the pandemic chaos and general housing frenzy triggered memories of the housing boom experienced just ahead of the Great Recession. Market fundamentals are very different today in comparison to 2007, including stricter lending practices, lack of housing supply and developed lots, and an abundance of real, pent-up demand. We are not building enough housing today.
- Interest rates are sub 3% and holding for now. While an uptick certainly impacts home buyers’ ability to stretch an overall monthly payment, we expect a more substantial impact on demand as interest rates approach and surpass 4%.
- Sales rates* are favorable across a variety of buyer groups. Entry-level, move-up, and active-adult buyers contributed to strong sales rates and continue to be very active in new-home communities. While sales rates have slowed since the 2020 peak, they continue to outpace the 2019 norm.
- Consumer demand exceeds new-home inventory.* At Zonda, we observe and tally homes under construction, finished vacant homes, and model homes and then compare that sum with the volume of new homes closed. The new-home months of supply fall short of demand in most Midwest markets.
- There is a shortage of developed lots.* Most Midwest builders sold through their home and lot inventory faster than planned resulting in not enough lots to meet today’s demand and, for some builders, future demand as well. Government service disruptions and labor shortages as a result of the pandemic have prevented builders from reacting to higher than anticipated demand and quickly ramping up lot supply. Builders typically plan their pipeline three to five years out, and it is challenging to switch gears in such a short period of time.
The home building industry has been one of the few bright spots during the pandemic by adding jobs, keeping supply chains moving, and helping consumers achieve the American dream of homeownership. While there are signs indicating demand is slowing from frenzied to normal, this is not the time to panic. Simply said, doom and gloom are not upon us.
(*) Note: contract sales rates, new-home inventory, and vacant developed lot inventory data are proprietary to Zonda. If you are interested in learning more about our products and services, please contact Danielle Leach directly.