America's Housing Rebound

Despite years of the highest real mortgage interest rates in almost two decades, construction and renovation spending have been holding steady, if not accelerating outright.

It is not surprising that homebuilding and home sales both tanked in 2022, as mortgage rates soared at the fastest pace since 1981. What is surprising is the extent to which many aspects of the market have rebounded in 2023 despite mortgage rates staying high. This resilience is further evidence that the U.S. economy is now able to withstand substantially higher interest rates than in the 2010s.

House Prices and Credit

Houses can last for decades, so the volume of existing inventory is always orders of magnitude larger than any year’s worth of new construction.¹ Houses also cost a lot of money, which means they are bought mostly on credit. And since few people are ever forced to move out of their current home at any given point in time, most potential buyers have the option to wait whenever market conditions are unfavorable.

This combination makes home sales and homebuilding extremely volatile—and extremely sensitive to changes in monetary policy. Housing may not be a big part of the U.S. economy, but swings in residential investment are usually large enough to play an important role in downturns and recoveries.² As the economist Edward Leamer memorably put it in 2007, “Housing IS the Business Cycle”.³

During the housing bubble years, conforming mortgage interest rates were relatively stable, but credit supply exploded via falling lending standards. With less documentation required and less money needed upfront for down payments, more and more people could bid up house prices with less and less income. This was not a problem as long as homes could get flipped to new buyers, but lenders eventually ran out of warm bodies. Home values flat-lined, which forced the most marginal borrowers into default, which pushed prices down, which forced lenders to tighten standards, which squeezed prospective buyers’ purchasing power, which pushed prices down more.

By the time things bottomed out, mortgage interest rates had become the most important driver of house prices. The surge in house prices during the pandemic was entirely consistent with the plunge in mortgage interest rates. The post-pandemic surge in mortgage rates was also consistent with the initial downtick in house prices. The turn in house prices since the beginning of 2023 represents a break in the prior relationship, but it is consistent with the broader re-accleration in U.S. growth and risk asset prices over that period.

The Impact on Construction

Prices tend to track sales volumes, which in turn tend to flow through to new construction starts. Starts soared during the pandemic and then fell sharply as conditions normalized, but have since been rising and now stand about 14% above the pre-pandemic run rate. The rebound has been particularly noticeable for single-family construction, which rose (and fell) much harder than multifamily when rates fell (and then rose). As of now, single-family construction is running faster than any time since the housing bubble, other than the pandemic.