Homebuilder Sentiment Is Looking Up At Last — Here’s Why The Real Estate Market Is Getting More Optimistic

Key takeaways

• Homebuilder sentiment is on the rise for the first time in over a year as mortgage interest rates noticeably dropped in early 2023. Mortgage interest rates are somewhat tied to 10-year Treasury yields, which have fallen with decreasing inflation rates.
• Just because sentiment is up nationally doesn’t mean it’s equal across all markets. It’s important for real estate investors to take note of regional trends.
• Hopefully this optimism will continue, but if global events impact financial markets in 2023, we could see a reversal, especially if inflation skews off its current course.

After 12 straight months of decline, homebuilder sentiment finally ticked back up again in January 2023 for the first time in a year.

The National Association of Homebuilders (NAHB) revealed last week that its national Housing Market Index (HMI) bumped up from December’s low of 31 to a more-encouraging 35.

In December, there were hopes that we had reached the bottom of the pessimistic streak, as the rate of decline had slowed even though sentiment was still going down. Fortunately, this prediction was accurate.

Why are homebuilders slightly less pessimistic though? We have waning inflation and its effects on financial markets to thank. Don’t worry, Q.ai is here to help.

Interest rates drop

Mortgage interest rates rose at a discouraging pace in 2022 as the Fed implemented its rate hikes to fight inflation. They surged to over 7% by October 2022.

While this was a disheartening metric for those who work in real estate, it was a market correction that needed to happen. Housing costs have been one of the primary reasons for inflation, whether we’re talking about homebuyers or renters.

Home prices had increased by a whopping 45% between December 2019 and June 2022, and rising interest rates served to cool the overheated market down.

But rates over 7% caused prices to drop. We saw a market correction in November 2022, when rates on a 30-year fixed mortgage fell to 6.61%. These rates more or less hovered around that number until Jan. 5, 2023, when they were 6.48%.

Over the first weeks of January, though, we have seen a meaningful drop with the average rate on a 30-year fixed mortgage, which fell to 6.15% as of Jan. 19, 2023.

10-year Treasury yield drops with inflation

The reason we saw a market correction in November 2022 was because mortgage interest rates had gotten too far ahead of the 10-year Treasury yield. This metric is commonly used to anchor mortgage interest rates, even in times when the federal funds rate is moving upwards.

What we’re seeing in the early months of January is likely attributable to a decrease in the 10-year Treasury yield. This yield has been on a downward trend in recent weeks as all the economic metrics, from unemployment to CPI to PPI, show a definitive slowdown in inflation.

Because the 10-year Treasury yield is on a downward trend, this parallel move in mortgage interest rates is to be expected.

Permits and new builds for single-family homes may rise

The NAHB is predicting that with increased homebuilder sentiment following the news of lower mortgage interest rates, we’re likely to see an increase in permits and new builds for single-family homes.

If this comes to fruition, it could increase inventory in this market sector. Homebuilders have primarily been focusing on multi-family units over the past year, as they viewed the rental market as a more viable move financially.

The shortage in single family homes was a partial contributor to the out-of-control pricing rally we saw earlier in the pandemic. Increasing supply could help not only the slowdown we’ve seen over the past year, but it could also potentially ease America’s affordable housing crisis if the number of permits and new builds increases in a meaningful way.

The most reason for optimism is in the West

Real estate is regional. While national trends are interesting, they don’t necessarily predict changes in each individual market equally.

The NAHB’s reports on the HMI both nationally and regionally. The HMI takes three metrics into account: present single-family sales, single-family sales for the next six months and traffic of prospective buyers.

The HMI bumped up by one point in Western markets in January 2023. In other markets, the optimism among buyers and homebuilders doesn’t seem to have materialized yet. The HMI stayed steady in the South, and actually dropped by a point in the Midwest and Northeast.

It will be interesting to see how this plays out, as the largest pricing decreases we’ve seen over the past year have been mostly in large, Western cities, though there have also been concerns about potential pricing decreases in cities where people moved with their remote work during the pandemic, like Pocatello, Idaho and Morristown, Tennessee.

Optimism is relative

It’s true that homebuilder sentiment has inched up. This swing in trajectory is particularly notable because it’s been on a downward trend in the 12 consecutive months prior.

But it’s important to put things in perspective. Homebuilder sentiment grew a healthy four points month-over-month to 35. While 35 is a better score than last month, generally, homebuilders are considered to be optimistic when the number is at 50 or higher.

It might not be appropriate to label current sentiment as optimism just yet. Though the change is exciting, it’s probably better described as less pessimistic.

Potential headwinds in 2023

The Fed intends to continue raising rates in 2023. We do not yet know the degree of these rate hikes, but we can be assured that further rate hikes are coming.

The good news is that this may be buffered by the 10-year Treasury yield if inflation continues to go down.

The bad news is that while it certainly looks like inflation is on its way out, there’s a lot that could happen to impact markets and supply chains in 2023. The IMF is predicting a recession in one-third of the world this year, and while America may escape it, Russia’s invasion of Ukraine and changing pandemic dynamics in China could easily cause further economic strife across the globe.

While we’re arguably the best-buffered country against the negative impacts of these world events, we are likely to feel some impact. The degree to which it will affect us remains to be seen.

If inflation starts moving upward again, we’d be much more likely to enter a recession that impacts the housing market further, as 10-year Treasury yield and mortgage interest rates would be more likely to reverse course and increase.

The bottom line

Even though it was unpleasant for homebuilders, the slowdown the housing market experienced in 2022 was necessary. The fact that things are starting to look less pessimistic this early in 2023 is a bit of a pleasant surprise.

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