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Housing market demand will come while challenges persist on supply amid mortgage rates: Economist

National Association of Home Builders Chief Economist Robert Dietz joins Yahoo Finance Live to discuss the housing market, housing inventory, home builder sentiment, and parts of the U.S. with the strongest home-building markets.

Video transcript

AKIKO FUJITA: Well, new housing data is putting the inventory crisis in focus. April housing starts rose a little over 2% after a dip in March. But building permits and completions both saw declines. Joining us for more on the housing market, we've got Robert Dietz. National Association of Homebuilders Chief Economist.

And, Robert, good to have you on today. A bit of a good with the bad in this report when you consider, number one, the pace of completions hit a 15 month low offsetting the housing starts that we saw hit a seven month high. To what extent is this a sign of things to come when you consider credit is tightening and you still have material shortages?

ROBERT DIETZ: Yeah, it's a reminder of the challenges the market faces. We desperately need new inventory. The level of resale inventory for single family homes right now is less than a three month supply. There are actually more realtors in the country than there are single family homes available for sale.

Builders are ready to begin to step up production. In fact, we have seen now five straight months of increases in the builder sentiment indicator that we publish here at NAHB. That's a good indicator that builders are feeling more confident about the market. That's driven by low levels of inventory.

But the availability of credit, building material challenges, and the ongoing labor shortages all represent significant obstacles for construction. So the only way we're going to solve the inventory crisis is by building more homes, but that challenge continues.

SEANA SMITH: Robert, what does the timeline look like on that, just in terms of how quickly or lack thereof-- I guess how long it could be until we see substantial improvement when it comes to inventory?

ROBERT DIETZ: Frankly, it's going to be a few more years. There's a lot of different estimates of the structural housing deficit that the United States faces. My team believes it is about 1 and 1/2 million homes. There are larger estimates out there. Freddie Mac believes it's 4 million homes.

But on the single family homebuilding side, we really need to be building a little bit more than 1.1 million single family homes a year in order to meaningfully reduce that housing deficit. Right now, say, 2023, we're probably only going to build somewhere between 800 and 900,000 homes. So that's just not going to do it. And that means it's going to be continuing a frustrating environment for prospective first time homebuyers.

AKIKO FUJITA: Yeah, those numbers you just put out there, pretty sobering and point to just the dynamic in the market right now and how uneven that is. We have seen a lot of buyers, or at least sellers, incentives driving sales. To what extent can that keep pace with the demand?

ROBERT DIETZ: Yeah. I mean, demand definitely weakened beginning in March of last year. So builders in particular were using things like mortgage rate buydowns to induce demand in the market. That actually was successful, because one of the things that we learned was the sweet spot in the housing market right now appears to be getting long term mortgage interest rates near or right below 6%.

According to Freddie Mac, mortgage interest rates are right at 6.4%. So our expectation is as we clear the point at which the Federal Reserve has stopped raising interest rates and bond markets began to anticipate slowing macroeconomic conditions, then mortgage rates will settle in by the end of the year in that 6% range.

So the demand is going to come, but the challenge is going to be on the supply side. The resale inventory is not going to hit the market, because you have a lot of homeowners sitting on 2% and 3% mortgage rates. And they don't want to sell their home because they don't want to give up that low rate. So you're not going to get help from the resale side.

So it's got to come from new construction. And of course, builders continue to face the fact that building material costs are up 35% to 40% from where they were pre-COVID. So there's a lot of obstacles in the way. I think this is something that's going to play out for the remainder of this decade. That's how long it's going to take to reduce that structural housing deficit.

SEANA SMITH: So, Robert, despite all of that and all the challenges that lie ahead for homebuilders, we are seeing their sentiment improve just a bit. Well, we're right around 50, the break even level. What are you hearing in terms of the optimism that's out there? What's behind that?

ROBERT DIETZ: Cautious optimism, driven by lack of inventory, which is competition in the new construction, space but ongoing concerns. One that's picking up right now, in particular, is impacts from some of the challenges faced by regional banks. For most homebuilders, in order to build a home, they've got to go and acquire land, develop lots, and actually construct that home before they sell it.

So that requires access to builder financing. And about 85% of that financing for private homebuilders comes from community and regional banks. The average rate of a development loan right now is above 10%. So that means a slower development pipeline, higher development costs, and ongoing challenges with inventory.

AKIKO FUJITA: Have we already started to see that pullback? When you talk about the direct correlation with the struggles we've seen in regional banks, I mean, you highlight that there's already been a 5% decline in deposits.

ROBERT DIETZ: Yeah, a little bit-- yeah, the 5% decline in terms of bank deposits as part of that story. I think the prime factor here is just the increase in the prime rate, which, of course, is a direct consequence of the Federal Reserve increasing interest rates. So yeah, anecdotally in our surveys, builders have said it's gotten more difficult to obtain that kind of financing.

And we're particularly seeing that, by the way, in the multifamily space. So our expectation is we're going to see a fairly large slowdown as we head into macro weakness on the apartment development side.

SEANA SMITH: Robert, in terms of what you're seeing on a regional basis, where are the strongest housing markets today?

ROBERT DIETZ: Yeah. I mean, when you think about the single family homebuilding market, more than 50% of it is in the South. 3 of the top 5 top building markets are in Texas. 3 of the top 10 are in Florida. And there are some pockets of strength outside the South.

The mountain states, which did experience a fairly large slowdown in 2022, we expect them to rebound because they've got strong population growth trends. And there's pockets of strength in the Midwest. Examples would include Columbus, Ohio, Indianapolis, places where housing affordability offers a real advantage for home buyers and employers.

So we've seen a lot of challenges in the coastal markets. That's going to continue. And that's due to lack of land availability and higher regulatory costs.

AKIKO FUJITA: Yeah, the cloud hanging over the sector, of course, has been, when are we going to start to see this rate hiking cycle ease? When you look to 2024, are we likely to see the bounceback then in the first part of the year? How do you look at that in the context of the housing market right now?

ROBERT DIETZ: Our forecast is like everyone else's. We think the Fed is effectively done-- maybe one additional rate hike, but unlikely. So the expectation is that the 30 year fixed rate mortgage will settle in near that 6% level by the time we get at the start of next year. So we think single family homebuilding right now is forming a bottom after about three quarters of significant weakness. We'll start to see the monthly data improve during the second half of this year. And that means 2024 is going to see a year of growth after years of decline in '22 and 2023. And as I said earlier, 2025 through 2030 look like a pretty good runway for homebuilding growth given that ongoing structural housing deficit.

AKIKO FUJITA: Yes. There's some light at the end of the tunnel. Robert Dietz, it's good to talk to you today-- Chief Economist at the National Association of Homebuilders.