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Supply-side challenges will persist in the eventual housing recovery

Due to the Fed’s fight against inflation, 2022 saw a significant pullback for housing demand. Single-family builder sentiment, as measured by the NAHB/Wells Fargo Housing Market Index (HMI), declined every month last year as homebuyers were priced out of the market and the building industry cooled. However, a housing rebound will occur later this year as some of these households are priced back into the market with improvements in interest rates.

However, the housing sector has not yet reached this turning point. In fact, January was a good test. Mortgage interest rates fell back to near 6 percent and demand increased, for a time, leading to a rise in new home sales and two months of gains for the HMI. The need for additional housing supply is clear. Existing home inventory, as measured by National Association of REALTORS, remains tight, and NAHB Economics estimates a structural housing deficit of 1.5 million residences. This deficit can only be addressed by the construction of new single-family and multifamily homes.

It is important to keep in mind that the eventual rebound for home building will be impeded in the quarters and years ahead by the very same factors that resulted in the structural housing deficit in the period after the Great Recession itself: namely, limits on the supply-side of the market. Currently, the market is seeing some limited relief from supply-chain issues that were a constant concern during the second half of 2020 and all of 2021. But these supply-chains are not healed.

For example, without policy or market capacity improvements, the lumber market will likely see higher costs, and therefore higher new home prices and rents, as single-family construction returns to trend. In fact, lumber prices crept up in January 2023 as hints of optimism were felt in the residential construction industry. The availability and cost of appliances ranks first among materials builders cite as experiencing shortages, with 88 percent of firms noting delays or other supply challenges. Second on that list is the availability of electrical transformers and other components, due to global trade issues. This is a severe issue. Without power, a residence cannot enter service. This potential showstopper for housing supply is affecting multifamily and single-family markets across the U.S.

Despite a reduction in builder demand for construction materials, the cost of these supplies remains elevated. Per NAHB analysis of Bureau of Labor Statistics  data, the average price of building materials remains 5 percent higher than a year ago. While that is an improvement over the 24 percent year-over-year gains experienced in late 2021, these cost increases are a reminder of the ongoing challenges for the industry. And behind these material challenges remains the persistent headache of the skilled labor shortage for the construction sector.

These data points are warnings that housing affordability, particularly for first-time and first-generation buyers and middle- and low-income renters, is dependent on the supply-side of the market. Improving domestic production of materials would help. The lumber market would gain additional certainty with a new softwood lumber agreement with Canada (and a reduction of tariffs on lumber, which act as a tax on new housing). Funding construction worker training programs at community colleges and trade schools and helping the work of the Home Builders Institute would assist builders and remodeling firms across the nation, in addition to providing careers/small business opportunities for those seeking a trade.

And of course, if housing stakeholders are serious about increasing affordable inventory, then we need to fight for regulatory reform with respect to costly and inefficient land development and construction policies. For example, according to NAHB research, about 24 percent of the price of a typical new singe-family home is made of such burdens, and an even greater share for apartments per NAHB/NMHC analysis.

Whether it be zoning reform, accelerating permit approval, reducing impact/permit fees, or other worthy reforms, these are the ways to bend the cost curve in the right direction and improve the prospects for additional affordable housing supply in the years ahead.

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