New Home Sales Mask Surge in Cancellations
The housing market slowdown has spillover effects for consumer spending
New home sales unexpectedly rose 7.5% in October from September’s downwardly revised figures. These sales are captured at contract signing and are a better leading indicator of housing market activity. Sales remained 5.8% below year-ago levels as high mortgage rates and high home prices eat away demand.
The problem is cancellations, which are soaring and not reflected in the data. With more homes sold that have yet to start construction, this trend will continue into next year as buyers get cold feet. Investors are fleeing the market, with one brokerage firm reporting a 30% drop in investor sales in the third quarter.
New home sales rose in the South, the largest housing market, as well as in the Northeast. The largest losses came from the Midwest. Compared to a year ago, the Midwest and West have seen over 20% declines in sales activity. The pandemic-era boom to housing markets in the South and West appears to be over, as the hottest markets in those regions are seeing the largest drops in sales and prices.
Mortgage rates peaked above 7% in October but have since fallen. This prompted mortgage application activity to pick up slightly in the middle of November. The drop in mortgage rates could be short-lived: the Federal Reserve is expected to raise interest rates again in December and continue to roll off their balance sheet, though it has been harder to reduce holdings of mortgage-backed securities given the desire by owners with low fixed rates to stay put.
Separately, sales of existing homes, which are captured at the contract closing and reflect contracts signed a few months prior, fell for the ninth consecutive month in October. Sales were 28% below year-ago levels and 33% below their peak of 6.7 million in January 2021.
Supply of existing homes available for sale remains low even as sales slow. Many homeowners are sitting on 3% or lower mortgage rates and are not keen to buy a new home at a 6.5% mortgage rate. Instead, many are renovating. This activity could be curbed by higher rates and tougher lending standards on home equity lines of credit.
Builders have pulled back on activity as well, keeping the supply of homes lower into next year even as more millennials age into their prime home-buying years. This will keep a floor on how low home prices can fall. We expect home prices to drop at a double-digit rate but remain much higher in 2023 than they were prior to the pandemic.
High mortgage rates and tight credit conditions are battering the housing market and residential investment activity. The new year is not expected to be any better, especially as this is traditionally a slower time for home sales. Those losses have spillover effects for the rest of consumer spending. Meanwhile, goods prices have begun to cool. The Fed needs to see a broader cooling of inflation to move to the sidelines.