Real Estate

The housing recovery isn't over, it just feels like it is

Key Points
  • Sales of new and existing homes are falling, construction of single-family homes is basically flat for the year, mortgage rates are rising, and affordability is weakening.
  • Demand is strong, thanks to basic demographics, an improving economy and a stronger labor market.
  • The trouble is that most of that demand is on the low end of the market, where supply is leanest.
New home sales down 1.7% in July
New home sales down 1.7% in July

A slew of negative housing numbers for July are piling up on top of a slew of negative housing numbers from the last several months.

Sales of new and existing homes are falling, construction of single-family homes is basically flat for the year, mortgage rates are rising and affordability is weakening. It certainly feels like the housing recovery that really took off in the last four years has come to a grinding halt, but it hasn't.

Is the ultra-hot and competitive housing market cooling off? Absolutely. Home prices rose too far, too fast, and the market is now hitting a price wall. We know that because the price gains are finally starting to shrink, according to a report this week from the National Association of Realtors. Anecdotally, real estate agents across the country are saying that their sellers are beginning to come back down to earth.

"I don't think the recovery is over," said Sam Khater, chief economist at Freddie Mac. "Economic growth is still very strong and essentially running at capacity. However, the consistent decline in housing affordability means there are fewer consumers who can afford to purchase a home."

The reason the housing recovery isn't over is because demand is very solid, and the price gains are starting to ease. As with all things real estate, however, location is key in this recovery.

"While the decline in home sales and deceleration in home price growth has been broad-based, the slowdown is more intense in the hot coastal markets -- which is a natural reaction to rapidly escalating home prices and higher rates versus a year ago," added Khater.

Improving market

"Recovery" is also not all about buying and selling houses. It is about the health of the housing market overall, and the market, while still too lean, is continuing to improve.

Foreclosure starts hit a 17-year low in June, according to Black Knight Inc., and mortgage delinquencies are at their lowest level in more than a decade. That includes a slight bump in troubled loans from states hit hard by last year's hurricanes.

The vast majority of homeowners are paying their mortgages on time, and an increasing number of homeowners are putting a lot of money into their houses, raising the value and adding to the remodeling economy of materials and retailers.

"Despite an apparent slump in the existing home sales data, the outlook for the home improvement market remains strong for the rest of the year," said Nino Sitchinava, principal economist at Houzz, a remodeling website. "At the start of Q3, remodelers on Houzz reported an average project backlog of 10 weeks, that is five weeks higher than the same time a year ago. Similarly, remodelers' expectations for new inquiries and new projects in Q3 remained high."

Homeowners are remodeling, in part, because they're getting richer. In just the first quarter of this year they gained a collective $1 trillion in home equity, according to CoreLogic, thanks to big gains in home values. The average homeowner gained just more than $16,000.

The number of homes in a negative equity position, meaning the borrower owes more on the mortgage than the home is worth, dropped 21 percent, from 3.1 million homes to just under 2.5 million homes. Negative equity now stands at 4.7 percent of all mortgaged properties; compare that to the worst of the housing crisis in 2009, when 26 percent of homes were in a negative equity position.

"With strong economic growth and higher purchase demand, we expect these trends to continue for the foreseeable future," wrote Frank Martell, president and CEO of CoreLogic, in a June release.

Affordability constraints

Demand for housing is still very strong, but yes, buyers are stepping back because of affordability constraints. There is just so much they can spend, and mortgage rates today are almost a full percentage point higher than they were a year ago. Sales of existing homes have been lower for five straight months, according to the Realtors, and mortgage applications to purchase a home have also been falling, although they are still slightly higher than a year ago.

"I think the market still has legs, but if rates continue to rise it will price out entry-level buyers and they have been carrying the market the last few years," said Khater.

Sales of newly built homes were lower in July compared with June, but they were still 12 percent higher than July 2017, according to the U.S. Census. These sales would be higher if homebuilders put up more homes on the lower end of the price scale, but margins are lower for entry-level product, and the rising costs of land, labor and materials are squeezing those margins more than ever. But make no mistake, the homebuilders are still recovering – increasing starts, sales and profits.

"While monthly home sales slipped, yearly growth pushed the three-month average to 8.1 percent, back above what is forecasted for 2018 (7 percent)," said Danielle Hale, chief economist at "This year's building and growth in new home sales have helped alleviate shrinking inventories for both new and existing homes which have been a major obstacle to home sales. Now home shoppers are starting to see more choices, but not necessarily in the price range they're looking."


This is not to say that the nation's homebuilders have fully "recovered." Far from it. They are increasing production, slowly, but they continue to battle significant headwinds, and they are still not building at historically normal levels, never mind accounting for huge pent-up demand. A historically normal level of single-family housing starts, going back 40 years or so, is about 1.1 million per year. That fell to a low of about 350,000 in the spring of 2009. Now it's back to about 850,000.

"Whatever progress has been made in new home sales since the economic recovery began, recent data makes it clear that builders have been struggling to ramp up new single-family home construction for years," said Aaron Terrazas, senior economist at Zillow. "If building levels had largely stayed near their historic norms and had kept pace with population growth, there would be millions more single-family homes nationwide, and the current imbalance between housing supply and housing demand would not be nearly pronounced."

The housing shortage has been the one glaring villain holding back a more robust housing recovery. Demand is strong, thanks to basic demographics, an improving economy and a stronger labor market. The trouble is that most of that demand is on the low end of the market, where supply is leanest.

"Builders need to manage rising construction costs to keep their homes competitively priced for the newcomers to the housing market," said Danushka Nanayakkara-Skillington, senior economist at the National Association of Home Builders. "While affordability conditions remain positive and the labor market sees low unemployment, prospective homebuyers face increased uncertainties as interest rates trend higher and trade war concerns grow."

Mortgage rates are higher now than they were one year ago, but not by a lot, and they are still, by historical measures, pretty low. It is the anemic growth in new home construction that is raising some red flags, even at the Federal Reserve.

"In contrast to other sectors, residential construction activity appeared to have softened somewhat, possibly reflecting declining home affordability, higher mortgage rates, scarcity of available lots in certain cities, and delays in building approvals," according to the minutes of the Fed's meeting that concluded Aug. 1.

The housing recovery may have peaked, but it isn't over. As more supply hits the market, sales will grow again. Consumer credit scores are still strengthening, a huge generation is aging into its homebuying years, and another huge generation is downsizing into active adult communities and urban condominium developments. While there is a new affinity for renting, that demand can fuel home construction and the overall housing economy as well.