The real estate market has been one of the most profitable sectors in the economy for years. However, the past few months have seen a significant slowdown in the industry. This has caused worry among many stakeholders, including contractors in the construction trade.
One of the reasons for the slowdown in the real estate market is rising interest rates. Higher interest rates mean that the cost of borrowing money to finance real estate projects increases.
This increase in cost results in a decrease in the number of people looking to invest in real estate, which in turn affects the demand for construction services.
The coronavirus pandemic led to a surge in the housing market as people sought new homes or expanded existing ones due to remote work and dining. However, the Fed’s attempts to curb inflation have caused mortgage rates to double, making homes less affordable for many.
As a result of rising mortgage rates, demand from homebuyers has slowed, leading to spiraling sales volume and prices. Another factor contributing to the slowdown in the real estate market is the tightening of credit standards.
“There has been a dramatic turnaround in buyer activity in a relatively short time,” said Lisa Sturtevant, chief economist at Bright MLS.
Financial institutions have become more cautious in lending money to real estate developers and investors. This has made it more challenging for these stakeholders to access financing to complete their projects.
Builder sentiment has also been negatively affected, with higher mortgage rates causing a decline in price growth and even a drop in some markets.
The National Association of Home Builders predicts that home prices could fall up to 15% from their peak, while commercial real estate is also getting hammered as cities recover from the pandemic witt empty office towers amid fears of an impending recession.
“Just months ago, buyers were falling over one another to bid up prices of new homes as the inventory of existing homes was at historically low levels. Now, in the wake of higher mortgage rates prospective buyers are canceling contracts and taking themselves off of waiting lists for new homes prompting builders to slash home prices.”
In a boon to priced-out homebuyers, home prices could drop by as much as 15% from the peak to the trough, according to NAHB.
That’s all raising the specter of a widespread housing construction downturn.
The US Census reported a nearly 19% year-over-year drop in housing starts for single-family homes in September, with building permits, a gauge of future construction, also decreasing by 17%. PulteGroup, one of the country’s largest homebuilders, saw its cancellation rate surge from 15% in Q2 to 24% in Q3.
For March 2023, the US Census Bureau reported Building Permits for February 2023 were 17.9 percent below the February 2022 rate of 1,857,000.
Privately‐owned housing starts in February were at a seasonally adjusted annual rate of 1,450,000, which is 18.4 percent (±8.9 percent) below the February 2022 rate of 1,777,000.
Although publicly traded homebuilders that have reported earnings thus far have shown robust results, this is largely due to a backlog of homes that went under contract in the spring, before mortgage rates reached 6% and 7%.
Builders are now preparing for the future, with some predicting a bleak market by the start of next year.
Despite currently having a strong balance sheet thanks to high-priced homes sold in the past, Myers, CEO of a homebuilding company, anticipates a hard landing for the housing industry, as customers who are accustomed to low mortgage rates are reluctant to buy homes at current rates.
“There already is a slowdown, but I think it will magnify itself in 2023,” said Ken Rosen, chair of UC Berkeley’s Fisher Center for Real Estate and Urban Economics. “A lot of developers may put projects on hold until construction costs come down.”
The demand for new homes has weakened due to buyers struggling to afford the higher mortgage interest rates associated with these residences.
Typically, new homes are pricier than older ones, and a drop in mortgage rates and prices is expected to lure buyers back into the market.
“There’s this cliff that’s happening in January,” said Gene Myers, Chairman of Thrive Home Builders in the Denver area, which was one of the hottest markets in the years leading up to and through the coronavirus pandemic.
The National Association of Home Builders predicts that housing starts, which refers to the start of construction for a property that has not yet been completed, will decline to around 744,000 single-family homes in 2023 as builders continue to hold back.
This represents a 12% drop from the previous year.
As a result, residential construction starts are not expected to reach their full potential until after the 2023 recession, where prices are expected to bottom out around 2025, with a recovery expected to take place around 2027.
In California, detached single-family residential construction has decreased by 19%, with 25,000 SFR starts taking place in the six-month period ending December 2022. 62,900 SFR starts took place in 2022, down by 2% or 1,600 starts from 2021.
The highest number of SFR starts occurred in 2005 with 155,000 starts, while the lowest was in 2011 with just 22,000 starts.
Multifamily construction, which had a strong year in 2022, is expected to decline by approximately 28% this year. However, there are still roughly 940,000 apartments under construction, the highest number since 1973.
According to First Tuesdays data, multi-family housing starts decreased by 7%, with 26,300 starts occurring in the six-month period ending December 2022, compared to the same period the previous year.
In 2021, 55,200 multi-family housing starts took place, representing a slight increase of 4% from the previous year, but still lower than the most recent peak in 2018.
The peak year for multi-family housing starts in the previous cycle was 2004 with 61,500 starts, while the lowest year was 2009 with only 9,500 multi-family housing starts.
The cost of land, materials, and workers has surged due to their scarcity, resulting in higher prices in recent years. Material prices increased during the pandemic, and the industry requires 740,000 new construction workers annually to keep up with demand and retirements.
Additionally, it has become more challenging for many builders to obtain financing for new projects, according to Dietz.
Contractors in the construction trade should be worried about the current state of the real estate market. With the decrease in demand for their services, they may struggle to find work. They may have to lower their prices to remain competitive, which could lead to a decrease in their profit margins.
However, by being proactive and innovative, they can adapt to the changing market conditions and remain competitive.
One option is to diversify their business and look for opportunities outside of the real estate, building and remodeling industries. This could include service businesses, government contracts, and infrastructure projects.
While the situation may seem dire for contractors in the construction trade, there are steps they can take to mitigate the impact of the real estate slowdown.