Broad Based Weakness Highlights the Headwinds from Elevated Interest Rates
Source: Economics Group of Wells Fargo Bank, N.A.
Summary
New Home Construction Slumps to the Slowest Pace in Four Years
Nearly pulling back all of April’s sequential gain, total housing starts fell 5.5% in May to 1.277 million units—the slowest annualized pace in four years. Weakness was broad based as both single and multifamily starts fell on the month. The forward-looking permit activity was also soft, suggesting builders have become less optimistic about prospective demand given persistent inflation and the higher-for-longer interest rate environment.
We anticipate interest rates to remain elevated in the near term, though project two Fed rate cuts in the second half of the year—September and December—that, if realized, would likely lead to a gradual lowering of mortgage rates and support new construction. The scarcity of existing homes on the market should benefit new construction, though affordability remains a substantial challenge for many homebuyers, particularly those purchasing for the first time. Housing demand is expected to remain reasonably firm reflecting the still-healthy labor market and supportive demographic trends. Sustained higher mortgage rates, alongside elevated construction financing costs and a dearth of buildable lots and chronic labor shortages, continue to weigh on home builders’ view about the outlook as evidenced by the second straight drop in the NAHB Housing Market Index in June.
Mortgage Rates Stifle Single-Family Construction
- Single-family starts dropped 5.5% in May, the third sequential slip. The 982K-unit pace is the slowest pace of construction since October 2023, the same month that mortgage rates peaked at 7.8%.
- High prevailing mortgage rates remain the millstone around the single-family market’s neck. The average 30-year fixed rate reported by Freddie Mac averaged 7% in both April and May and is on course for a three-peat in June.