US housing construction is dead with current mortgage rates

New home sales missed sales estimates significantly in Wednesday’s report and we have negative revisions to the previous months. The builders’ profit margins are dwindling, which means housing construction, which has been at early COVID-19 recession levels for some time, could worsen if mortgage rates stay elevated or head even higher.

So, instead of focusing on the new home sales report directly, I want to show you why housing permits and housing starts are at recessionary levels even though new home sales have stayed within a range for many years now.

Builders’ confidence is in the dumps

The homebuilders’ confidence data, which primarily reflects the views of smaller builders, is currently close to the lowest levels seen during the COVID-19 recession. Late last year, despite rising mortgage rates, builder confidence started to improve. I believe this optimism was largely based on the expectation that mortgage rates would decrease this year and on the expected reduction in regulations. However, mortgage rates are now near 7% and ongoing discussions about tariffs have made the situation more challenging. 

I am realistic about how low mortgage rates can go, given the Federal Reserve‘s restrictive policy for housing. Nevertheless, whenever mortgage rates have approached 6% in the last few years, both housing data and builders’ confidence improved. It seems that holding back an entire industry over an 0.80% basis point change is an ineffective way to manage this part of the economy. I am not talking about 3%, 4% or even 5% mortgage rates, but if 6% is a no-go, then expect less construction going out.

Builders manage their completed supply carefully

One of the things I don’t believe people understand about homebuilders is that they’re not the March of Dimes; they sell homes as a commodity, and they have to be mindful of their profit margins or else they need to start laying people off. With that in mind, the completed units for sale hit 119,000 today. Now, that doesn’t seem like a lot of homes, but historically speaking, as the chart below shows, the builders tend to stop building when completed units of sale get around 120,000.

It’s important to note that the number of homes that have not yet started construction has reached a record high of 117,000. If you’re wondering why builders haven’t laid off workers yet, it’s because they have projects ready to begin, but they are waiting for lower mortgage rates. However, as profit margins continue to decline, it is only a matter of time before they can no longer maintain their labor force if sales data worsen.

Conclusion

This article takes a different approach to explain why housing starts and permits have stalled and are currently sitting at recessionary levels. I recently noted that homebuilders are hesitant to increase permit production. The new home sales report indicates that the housing market has remained stagnant in terms of sales for several years, with only a glimmer of hope emerging when mortgage rates approach 6%.

However, until that happens, don’t look for the housing construction boom that so many people were talking about for years. I wrote back in June of 2021 that once rates rose, reality would hit those looking for a construction boom, and in fact, 2022 was the peak of housing construction data. We haven’t been able to get permits or starts back toward cycle highs since mortgage rates rose in 2022, even with the homebuilders paying down rates.