2023 Residential Construction Outlook
Tightened monetary policy brought increased interest rates in 2022, which has caused a significant slowdown or recession for housing. Home building will experience additional weakness in 2023 due to the Federal Reserve’s intent to hold elevated rates in place to fight inflation.
However, by the second half of the year, this short, sharp housing downturn will give way to a rebound. Moderating interest rates will strengthen housing demand and single-family construction will help lead the economy to a recovery.
Despite recent improvements for inflation, price growth remains stubbornly high. Recent CPI data shows prices still growing at 7-plus percent year-over-year rates. To fight this persistent inflation, the Fed continues to tighten monetary policy. The Fed has raised the federal funds rate by 425 basis points since March, placing short-term rates at their highest level since 2008.
These tightened financial conditions have significantly slowed multiple sectors of the economy, including real estate. The National Association of Home Builders (NAHB) forecast sees five of six quarters showing a GDP decline from the start of 2022 until the middle of 2023.
The two quarters of GDP decline for the start of 2022 should have been enough to make the call, but some academic economists want to see an increase in the unemployment rate before declaring an “official” recession.
But the labor market remains tight due to an ongoing rebound in jobs from COVlD-era employment declines. In fact, it was only in August 2022 when total nonfarm employment was back to the pre-pandemic level in February 2020.
The unemployment rate was 3.7% in November, close to cycle lows. But even the Fed sees the labor market softening, with their projections from earlier in the year forecasting that the unemployment rate will increase to 4.4% in 2023.
However, it is the interest rate cycle that will set the future course for the economy. This year we have seen mortgage rates rise to a 20-year high in November. While rates stabilized later in the fourth quarter, additional rate increases from the Fed in early 2023 will place upward pressure on long-term rates at the start of 2023.
These elevated rates will continue to weaken housing demand, with the NAHB/ Wells Fargo Housing Market Index at decade lows after 12 straight monthly declines.
The NAHB sentiment reading is signaling additional declines in 2023, but by the end of the year moderating rates will see a rebound begin for single-family construction.
Turning to the other side of the market, a rising unemployment rate and growing supply will slow the apartment market in 2023. Though multifamily starts posted strong gains in 2022 due to low vacancy rates and solid demand for rental housing, multifamily construction will fall back in 2023. Indeed, the NAHB Multifamily Production Index is currently at its lowest reading since the Great Recession.
However, there are some submarkets showing ongoing, positive conditions. Custom home building expanded during the third quarter of 2022 despite broader market weakness. Custom construction benefited from improved supply chains, a reduction in the growth rate of the cost of building materials and a stock market rally that helped the higher end of tl1e market.
Single-family built-for-rent construction now makes up more than 10% of the single-family building market (compared to a 3% historical average). And the remodeling market continues to show solid conditions as an aging housing stock and housing equity drives demand for home improvements.
If 2024 will be a year of continued rebound and recovery, familiar supply-side concerns will come to the forefront once again. The skilled labor shortage will persist over the next decade. The lumber market requires additional domestic production. And the AD&C loan market will likely be tight in 2024, even as demand for housing is rallying. This will place pressure on lot supplies as the recovery gains momentum.
Looking further down the road, the U.S. housing market remains underbuilt by about 1.5 million homes, per new NAHB estimates. This structural housing deficit will fuel a recovery for single-family home building with the industry ultimately starting construction on a little more than I.I million homes per year during the 2025–2030 period. This five-year period represents a good runway for growth, once we navigate out of the ongoing downturn produced by the central bank’s fight against inflation.
Robert Dietz is Chief Economist and Senior Vice President for Economics and Housing Policy for the National Association of Home Builders. He can be reached at RDietz@nahb.org.