Thinking Ahead: Competing Pressures on Housing Demand and Evergrande’s Potential Market Effects

While much of the talk this week still centers around the pending infrastructure bill and what Congress will pass (if anything), FMI’s team is also paying attention to several factors disrupting the demand for real estate.

Pressures on Housing Demand

In looking at the current demand for housing in the U.S. there are several competing factors that are weighing on the markets. The catch is determining what is going to have the biggest effect on demand and for how long.

Recent data from the U.S. Census Bureau shows that sales of new single-family homes dropped 24.3% in August from the prior year. Inventories for sale rose to 378,000, the most since October 2008, signaling that the national market is back in balance.

On the other hand, supply chain issues are making it difficult for builders to find the materials to start or finish homes underway. Problems sourcing materials and labor to complete construction means that many homes are sitting waiting to start or are partially completed. All these shortages have driven up the cost of building a new home 12.8% in August compared to a year ago, excluding land and other non-construction costs.

Yet we believe the biggest driver of future demand for homes will be affordability, and one key factor impacting this is mortgage rates. With the Federal Reserve indicating that rates may begin to increase in late 2022, many are trying to lock in lower rates now, indicating there could be a potential short-term uptick in demand before longer-term downward pressure as pricing naturally adjusts to higher rates.

On the other hand, overall new home affordability is at its lowest level in history, with the percentage of new home inventory priced over $400,000 is higher than 50% for the first time ever. Driven in part by supply chain issues and in part by policy preferences, this affordability gap is likely to have an even greater negative impact than the expected future rate increases.

Evergrande

Last week global markets were rattled when China Evergrande Group, the second-largest real estate company in China, looked close to defaulting on a portion of its $300 billion debt. With the Chinese government moving to shore up the company, stability has returned this week, but the crisis is far from over and offers some insights into the country’s rapid growth.

As much as 29% of China’s gross domestic product is tied to the real estate industry. Much of Evergrande’s $300 billion in debt is tied to homes that were purchased before they were built. Given the current constraints on supply chains and building products, homebuilders in the U.S. may find they’re having to compete for supplies with other countries making huge investments in building.

With China’s growth heavily dependent on real estate, the shift in the government’s policy to stamping out speculative housing development could have far-reaching implications for how it will continue to grow. Many expect that if there’s turmoil in Chinese real estate and financial markets, a portion of those losses will spill over onto the rest of the world.

Conclusion

Homebuilding continues to be a significant driver of overall construction put in place for the foreseeable future. As we continue to crunch the numbers for our fourth quarter forecasts and are thinking ahead to 2022, check back for our next (fourth quarter) Outlook publication in early October.