This housing market is a tale of 2 markets, housing economist Ali Wolf says

A few days ago, Wells Fargo analysts published an article with the headline, "Rising borrowing costs stand to tip the housing sector back into recession." According to Wells Fargo, the recent increase in the average 30-year fixed mortgage rate, which now sits at 7.69%, has dimmed the prospects of a housing rebound.

Without a doubt, existing home sales for this quarter are anticipated to be subdued, especially considering that mortgage applications this morning reached their lowest level in the post-1995 era. One significant factor contributing to the low existing home sales is the scarcity of new supply entering the market, with many sellers reluctant to part with their low monthly payments.

But is Wells Fargo correct in asserting that the new construction market—which had slipped into recession mode in the summer of 2022 but began to recover in early 2023 due to mortgage rate buydowns and price cuts that lured buyers back—is once again in a recession?

Rather than just taking Wells Fargo’s word for it, let’s do some digging.

To gain insights into the current state of the single-family home construction market, ResiClub reached out to Ali Wolf, the chief economist at Zonda, an analytics firm specializing in new construction.

According to Wolf, the U.S. housing market in 2023 continues to reflect a tale of two housing markets, with the existing/resale market experiencing a different reality than the new construction market.

Lambert: Over the past few months, mortgage rates have steadily ticked up. Now, the average 30-year fixed mortgage rate is hovering just below 8%. How do you expect this recent run up in mortgage rates to impact the new home market?

Wolf: The housing story of 2023 was the tale of two markets. The existing home market was constrained due to limited supply and worsening housing affordability. The new home market outperformed thanks to a compelling value proposition of a brand-new product with incentives and discounts available. The new home market is still outperforming the resale market but is not immune to the headwinds. An 8% interest rate plus home price growth translates to a 90% increase in the typical monthly mortgage payment compared to the beginning of last year. There are still some individuals that can brush off the affordability crunch, including all-cash, relocation, and generally wealthy shoppers, but many prospective homebuyers have moved back to the sidelines. October appears to be an inflection point for the new home market.

Lambert: In the second half of 2022, the housing market—in particular the new home market—was amid a bit of a correction. However, right off the bat this year, the new home market began to stabilize, and some builders even began to once again raise house prices. Any thoughts on what could happen to new home prices between now and the end of the year?

Wolf: After builders slashed prices in the second half of last year, many found themselves with pricing power this year. For the majority of 2023, homebuilders reported to Zonda prices flat to up. The limited, old, and expensive resale supply funneled people into the new home market. We noticed a shift in October. In October, most builders held prices flat, with lowering prices as the second highest response. Incentives have been the key to builders holding prices steady. We’ll see incentives remain commonplace through the rest of the year and price cuts return to communities where sales have slowed the most.

Lambert: What incentives are homebuilders finding the most success with?

Wolf: Builders report the most effective way to get consumers off the sidelines is through mortgage rate buydowns, funds towards closing costs, and flex dollars. Put a different way, builders are figuring out the pain point of individual buyers and finding the best workaround for them. Is the consumer monthly payment concerned? Buydowns. Are they tight on cash? Closing costs. Are they paying all cash? Give them funds towards options and upgrades.

As of October, the majority of builders are buying down fixed-rate mortgages to the mid-5%s to low-6%s. The majority of the funds towards closing costs fall between $5,000 and $20,000.

Lambert: Back in the summer you told me "objectively, the housing recession in the new home space is over", however, you were "watching closely to see if there’s a double-dip recession in housing or if demographic-supported demand is enough to withstand wider issues." What are you seeing now?

Wolf: I’m still on recession-watch for the new home market. Last year sales fell off a cliff in the new home market starting mid-year. We are seeing the cooldown I mentioned that started in the 4th quarter, but I’m not ready to say the new home market recession is back on. It takes more than one month to make a trend.

Lambert: Last fall, Western markets such as Boise and Phoenix experienced sharper price declines, while many Midwestern and Northeastern markets remained stable. As we fast-forward to this winter, do you still observe any kind of bifurcation in the housing market? And where are you seeing the most strength, and the most weakness?

Wolf: There’s no doubt that the East/West divide in home sales is still there. Even with the slowdown, the Eastern part of the U.S. continues to be stronger than the Western side. However, there are some markets in the Southeast, for example, that sentiment on the ground has turned negative. I attribute this to the fact that there wasn’t such a dramatic slowdown last year, so the cooling experienced today feels abnormal. In many top Western markets, housing demand was so weak last year that today feels better, all things considered. It’s all about perspective. Parts of the Southwest and Mountain West continue to underperform, however, including parts of CO, TX, UT, and AZ. The Midwest, historically a steady eddy part of the country, has outperformed this year thanks to relative affordability and healthy labor markets.

On Saturday, the Lance Lambert House Price Tracker went live. The beta version has metro-level analysis; however, county and ZIP code data will be available soon. This offering is for just ResiClub Pro members.