U.S. housing: Cyclical weakness, structural strength

The 2007 subprime mortgage crisis brought on the sharpest downturn in the housing market since the Great Depression. While credit conditions were partly to blame, so was overbuilding in the years leading up to the crisis. Privately owned housing unit starts were running at a breakneck pace approaching nearly 2 million a year, according to the Federal Reserve. That contributed to a significant surplus in houses on the market in 2007, as the first chart shows.

Following that crisis, annual housing starts fell below 500,000, with dozens of home builders merging or going out of business and many laid-off construction workers exiting the industry. With those developments and an abundance of caution among surviving residential construction companies, the pace of construction really only ramped up again in the last several years. The result was an acute undersupply of available homes.

More recently, supply has further been held back by a rapid rise in mortgage rates.

“We’ve seen almost a doubling in mortgage rates over the last 12 months, climbing from around 3% or 4% to closer to 6% or 6.5%,” said Ian Kresnak, a Vanguard investment strategist. “That’s created a pool of homeowners—about 90% of all homeowners by our calculations—who might be ready to move and have built-up equity given the sharp rise in housing prices since the pandemic, but don’t want to sell because they would lose the low financing costs they have locked in. That’s a supply headwind of a magnitude we haven’t seen since the late 1990s.”

New construction starts have been trending higher in recent years, but a lack of workers, a dearth of available land, and a shortage of and higher prices for building materials have made a rapid rebuilding of supply challenging.

“With the Federal Reserve in the later stages of its rate-hiking cycle, we expect the worst of price decreases and sluggish sales and starts to be behind us,” Hirt said. “Recent data on home sales and starts are supporting this view, where we have seen what appears to be a bottoming already underway.”

“Even when interest rate volatility subsides, we expect that mortgage rates will remain elevated in a range around 5%, which will continue to act as a hurdle to supply,” Kresnak said. “However, we’ve estimated that tight supply will keep home prices from falling as much as they might have otherwise—to a 5% year-over-year decline at most—which could encourage more housing starts.”

That, along with supportive demographic trends and strong borrower fundamentals, should put housing on the path to becoming an economic stabilizer, with negative contributions to GDP since mid-2021 turning positive by 2024.