Homebuilders face a tough balancing act on new construction amid high mortgage rates

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Homebuilders are walking a fine line when it comes to new projects as high mortgage rates curb demand.

New residential construction, including single-family homes and multifamily, dropped 11.3% month over month in August to 1.283 million units on a seasonally adjusted basis, according to Census Bureau data released Tuesday. That’s down 14.8% compared with a year ago and well below the 1.44 million units economists surveyed by Bloomberg projected.

But authorized residential permits — an indicator of potential future activity — rose 6.9% to 1.543 million permits in August from July. That was still down 2.7% from last August. Single-family permits, though, were up 2% from July to 949,000. Multifamily permits came in at 535,000.

The data reflects two opposing forces builders are trying to balance: the ongoing need for new construction to fill in limited inventory and elevated mortgage rates that are hurting their biggest customer right now, the first-time homebuyer.

“High mortgage rates are clearly taking a toll on builder confidence and consumer demand, as a growing number of buyers are electing to defer a home purchase until long-term rates move lower,” Robert Dietz, chief economist of the National Association of Home Builders, said Monday in a press release after builder confidence dropped for the second straight month.

Read more: Mortgage rates at 20-year high: Is 2023 a good time to buy a house?

More homebuilders see housing conditions as poor than good, according to the National Association of Home Builders (NAHB)/Wells Fargo Housing Market Index (HMI) for September, with the index reading of 45 falling below the key break-even measure of 50 for the first time in five months. Economists polled by Bloomberg anticipated an index reading of 49 for September.

Additionally, builders have a more muted outlook than before. The index’s component measuring sales expectations in the next six months declined six points to 49, and the index recording traffic of prospective buyers dropped five points to 30.

“The two-month decline in builder sentiment coincides with when mortgage rates jumped above 7% and significantly eroded buyer purchasing power,” NAHB chairman Alicia Huey, a custom homebuilder and developer from Birmingham, Ala., said in the press statement.

Rates remained above 7% for the fifth week in a row, with the latest average rate on the 30-year fixed mortgage at 7.18%. Many buyers who rely on financing have retreated to the sidelines as unaffordability once again exacerbates the market.

Read more: What the latest Fed rate hike plan means for mortgage rates and loans

“Home buyers face the most difficult affordability conditions in nearly 40 years due to limited inventory and rising mortgage interest rates,” Jessica Lautz, NAR’s deputy chief economist and vice president of research, said in a recent release.

New homes construction site New homes construction site

New homes construction site

The decline in home starts may reflect builders’ expectation of slowing demand, the increase in permits may underscore how acquiring buildable lots remains a big priority. New home construction likely will stay a key piece in the housing market as long as the existing-home inventory is depressed.

For instance, new construction sales reached a record-high share of homes on the market, according to the National Association of Realtors. New home sales made up about one-third of inventory on the for-sale market in the second quarter, when they typically only account for 10%.

That is because there are relatively fewer existing homes on sale than new ones due to the mortgage rate lock effect. Homeowners are reluctant to sell their homes now in a high rate environment because they would sacrifice their current low mortgage rate.

“New construction is the only option for many buyers,” Shauna Pendleton, a Redfin real estate agent in Boise, Idaho, said in NAR’s press release.

Builders are also drawing in more entry-level buyers.

The NAHB found that 42% of new single-family homebuyers year to date were first-timers. That is substantially higher than the 27% during a more normal market in 2018.

But that doesn’t mean homebuilders have it easy, especially as mortgage rates remain above 7%, pressuring first-time buyers who typically come to the table with lower down payments.

To help, almost one-third of homebuilders discounted home prices in September to boost sales, compared with 25% in August, the NAHB found. This marked the largest share since December 2022, when 35% of builders reduced costs.

“Builders are still confronting many challenges, including rising mortgage rates, supply chain issues for electrical transformers, a dearth of skilled workers and elevated construction costs,” Huey said.

Rebecca Chen is a reporter for Yahoo Finance and previously worked as an investment tax certified public accountant (CPA).

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