WAITING ON THE COMEBACK
Housing demand on the rebound from
higher interest rates, inflation
By Alan Ferguson
Homeownership is an American dream. It’s also a key driver of the property/casualty insurance industry. Each home buyer is a potential customer for the personal lines channel. Consumers require all types of coverage once they own a residence, and it generally expands over the years, including builders risk insurance when adding on to or renovating their houses. Commercial construction companies also make up a big market potential for agencies.
The dynamic residential construction market has always been closely watched for home price and sales trends as well as for what it indicates about the larger economy. It’s intertwined with interest rates, inflation and economic growth.
After posting red-hot growth in 2021, the residential construction market declined during the last half of 2022. However, current economic factors indicate a comeback between late 2023 and the first quarter of 2024.
U-shaped housing market index
One widely watched indicator of residential construction is the National Association of Home Builders/Wells Fargo housing market index (HMI), which rates the relative level of current/future single-family home sales on a scale of zero to 100. The index was well above 70, a strong showing, through the first four months of 2022.
But the HMI’s been in a “U” shape ever since, falling from a high of 77 in April 2022 to 31 in December 2022. By March 2023, it had rebounded to 44, its highest since September 2022.
The index indicates recent changes in the dynamics in housing: higher inflation, continued construction issues, and heightened interest rates.
Higher inflation. Inflation in the “shelter” category affects residential construction, and it remained high at 8.1% as of February 2023 compared with a year earlier. Other categories that affect residential construction, such as transportation and fuel, are also up sharply. The Federal Reserve Board (Fed) has raised market interest rates in a declared effort to slow high inflation, and many analysts forecast further rate hikes in 2023.
I think of 2023 as a “gap year.”
Builders need some downtime to
catch up on existing projects and prepare
for what is to come.
Inflation has pushed up costs for buyers of existing homes and heightened the costs of materials for new homes.
Continuing construction issues. Disruptions in supply chains are still affecting construction. Labor shortages also remain a challenge, especially for skilled trade contractors such as drywall installers, carpenters and rock pavers, to name a few.
Heightened interest rates. High-er mortgage interest rates in 2022 and 2023 are tamping down on potential home buyers’ purchasing power. The interest rate for a 15-year fixed-rate mortgage loan was 5.56% as of the end of March 2023, up markedly from 3.83% as of the end of March 2022.
That makes a decided difference in a buyer’s ability to handle loan payments. At the lower interest rate, the monthly payment on a $100,000 mortgage is $863. At the higher rate, it is $952. Multiplied across the housing market, those higher mortgage payments are keeping Americans from buying homes at the same volume they did last year.
Put another way, higher interest rates reduce by millions the number of people who can afford homes. That’s a key reason why the housing market index has sagged.
”Gap year” for housing market
It’s fair to say that the housing market right now is in a lull due to market factors. I think of 2023 as a “gap year.” Builders need some downtime to catch up on existing projects and prepare for what is to come. In my view, the housing construction market is primed to come roaring back. It’s just a matter of time.
The desire to own a home is not something that goes away. As the population grows, new people entering the prime homebuying years of their 20s and 30s drive demand for existing and new homes. Many people in this age bracket were forestalled in their household formation plans by the recent pandemic, just as they were reaching peak ages to purchase homes.
[E]ven with lower construction
activity, it’s important to
remember that housing demand hasn’t gone
down permanently—it’s just been suppressed
temporarily by economic factors.
There’s now pent-up demand among millennials and Generation Z. Many missed out on opportunities to buy when rates were in the 3% to 4% range because a surplus of buyers—namely baby boomers looking to downsize—bid up home prices.
Now, even with lower construction activity, it’s important to remember that housing demand hasn’t gone down permanently—it’s just been suppressed temporarily by economic factors. Based on estimates of population trends, the U.S. housing market is in a long-term short supply of approximately 4 million housing units.
During the housing cycle, it’s interesting to watch the interplay between single-family homeownership and multi-family housing. As single-family homes become more difficult to afford, buyers shift (even if temporarily) to multi-family alternatives like condominiums or renting. At the same time, the supply of existing single-family homes is restricted by a different dynamic. As selling prices look less appealing to current homeowners, those seeking to downsize from their home for a smaller condo or apartment hold off.
What agents should watch
As Fed rate increases tail off, mortgage rates will level out and start to turn down. If mortgage rates fall to the range of 5% to 5.5%, that likely will spark buying in the single-family home market—creating a surge in builders risk insurance opportunities for agents, whether for new construction or remodeling.
Another item to monitor is the rate of inflation. The Fed has stated that its target inflation rate is 2% annually. If and when inflation gets toward the 4% to 4.5% range and mortgage rates begin to drop, first-time home buyers in particular are going to become much more active in the housing market.
Builders risk insurance plays a key role in creating secure homeownership. It protects builders and buyers of new houses under construction, and it safeguards existing residences and other structures undergoing renovation.
While the coverage can be purchased in the name of the contractor or owner, many falsely assume that a homeowners policy will adequately provide the coverage and limits required to protect course-of-construction risks, such as theft of building materials, property in transit, fire, flood and more. It’s up to agents to be sure clients have the right protection in place before construction begins.
Agents should also be aware of the commercial business opportunity that surrounds new communities. There tends to be a surge in the construction of multi-family housing. Closely following is the “convenience” infrastructure of businesses to support the increased population—think restaurants, grocery stores, retailers, dry cleaners, pharmacies, gas stations and other supporting establishments.
In summary, agents can expect to see a surge in single-family housing nationally, maybe as early as year-end 2023. As interest rates drop back down, the demand for existing homes and new construction will rise again. In the beginning of 2024, the housing market likely will look a lot like it did in early 2021 coming out of the pandemic. n
Alan Ferguson is president of US Assure, where he leads corporate strategy and the day-to-day operational decisions for the company.
US Assure exclusively distributes, underwrites and services Zurich’s builders risk insurance program across the U.S.