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Prices And Interest Rates May Be Weighing On Housing

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Includes: HOML, ITB, NAIL, PKB, XHB
by: American Institute of Economic Research

By Robert Hughes

Sales of new single-family homes fell 1.7 percent in July, though they are still up 12.8 percent from a year ago. Sales came in at 627,000, down from 638,000 in June. On a three-month-average basis, sales came in at 640,000, down 2.4 percent from the prior three-month period and the slowest pace since October 2017. Sales activity is broadly in line with levels from 1985 through 1995 but remains well below the pace between 1995 and 2007 (see chart).

Across the four regions, sales in July plunged 52.3 percent to 21,000 in the Northeast and fell 3.3 percent to 355,000 in the South. However, sales did rise 9.9 percent in the Midwest to 78,000, and increased by 10.9 percent to 173,000 in the West. From a year ago, sales are down 48.8 percent in the Northeast but are up 18.2 percent, 17.2 percent, and 18.5 percent for the Midwest, South, and West, respectively.

Total inventory of new single-family homes for sale rose 2.0 percent to 309,000 in July, pushing the months' supply (inventory times 12 divided by the annual selling rate) to 5.9 months, up from 5.7 months in June. That is the largest months' supply since August 2017.

Slowing sales and rising inventory are coinciding with slowing construction and permit issuance. Single-family housing starts rose just 0.9 percent in July to 862,000, the second slowest pace of 2018. Current new construction activity remains well below the levels in the economic expansions of the past 30 years (see chart again). Starts fell in two of the four regions, dropping 5.7 percent in the Northeast and falling 10.0 percent in the West.

Offsetting those declines were a 22.3 percent surge in the Midwest and a 2.0 percent rise in the South. Permits for future construction rose 1.9 percent for all single-family housing, with gains of 4.9 percent in the West and 1.9 percent in the South offsetting a 5.4 percent drop in the Northeast. The Midwest region had no change in permits for new single-family housing construction.

The combination of rising home prices and higher interest rates is likely weighing on housing activity in general. Home affordability overall has been trending lower after surging from 2009 to 2012 because a combination of extraordinarily low interest rates and falling home prices then made for a buyer's market. For the housing market overall, affordability remains favorable, though the declining trend is likely to continue. For first-time home buyers, affordability is less favorable. Though it did surge along with overall housing affordability in the 2009-12 period, it then continued at much lower levels and is now close to neutral.

Declining affordability due to rising home prices and rising interest rates is likely to continue weighing on housing activity in general. Sales are unlikely to move significantly higher in the coming months, and new-home construction is unlikely to contribute significantly to growth in gross domestic product in coming quarters.

Still, the economy overall remains very healthy, supported by a tight labor market, rising incomes, strong balance sheets, and high levels of consumer confidence. The main risks on the horizon are fallout from escalating trade wars and the ballooning federal deficits, which are likely to require significant funding in coming quarters and may drive long-term rates significantly higher.