What the Housing Market Slowdown Means for Real Estate Developers

At the start of this year, the American residential real estate market was red hot, with home pieces exceeding $400,000 for the first time ever in the second quarter. But rising inflation, a recession, and multiple interest rate hikes have  cooled it off considerably. Multinational banks and market analysts don’t believe the segment will not improve until next year. Morgan Stanley, Goldman Sachs, Moody’s Analytics, and Wells Fargo expect home prices to dip by at least 5% next year. 

With  mortgage rates at a 20-year high, home purchasing isn't rebounding to its 2020/2021 levels in the near term.

A potential 2023 recession won’t have the same devastating impact on the housing market as the 2008 economic slowdown. And the gap between supply and demand in the U.S. marketplace is an issue that will revitalize the asset class down the line. The key to capitalizing on that imbalance is knowing when and where to launch new residential projects.

Why the 2023 Housing Market Won’t Mirror the 2008 Collapse 

In 2008, the American housing market collapsed and triggered a severe economic contraction dubbed the Great Recession. But the unique circumstances that contributed to that event aren’t in play now.

The 2008 crisis began because lenders issued  subprime mortgages in earnest to give borrowers with less-than-ideal credit the ability to become homeowners. Unfortunately, 36% of those loans were  adjustable rate mortgages (ARMs) with low initial monthly payments before becoming substantially more expensive. As the formerly booming housing market faltered, home prices fell, ARM rates spiked, and homeowners nationwide defaulted on their loans, pushing the economy into recession.

Since then, however, the U.S. housing market has  undergone significant changes and no longer operates with as much risk.

Although home purchasing saw  a big upswing in 2020 and 2021 related to COVID-19, the new generation of borrowers didn’t make the same mistakes as their predecessors. According to Newsweek, ARMs only are 8% of all U.S. mortgages, and 80% of those ARMs are under a fixed rate for their first 7 to 10 years. Also, U.S. homeowners gained a record  $2.7 trillion in home equity last year, meaning they’re in a stronger financial position than in 2008.

Even if the housing market’s weakness lasts throughout 2023, we aren’t going to see a repeat of the 2008 collapse.

The House Market’s Undersupply Problem

The Mortgage Bankers Association recently determined that mortgage demand has plummeted to its lowest level since 1997. Economists have blamed the home buying slowdown on the Fed’s recent interest rate hikes. Bankrate reports that mortgage rates for  30-year fixed-rate loans are at 7.08 %, the highest in 14 years. As market watchers expect interest rates to  climb even higher before the year's end, housing market demand will stay cool.

The segment’s continued slump is reflected in the construction sector, which saw an 8.1% annual decrease in home builds in September. Homebuilder sentiment is also declining,  falling to 38 points - its lowest level since May 2020 - in October. Until demand rebounds, investors aren’t going to back many complex multifamily projects.

That means the housing market’s supply-demand imbalance won’t be corrected this year.

As  The Real Deal explained, housing inventory across the United States is historically low. Like  the retail segment, the lingering financial fallout of the Great Recession has curtailed interest in residential real estate development. Moreover,  rising raw material costs and  a labor shortage in the construction sector have resulted in a severe residential property undersupply. Because inventory isn’t keeping up with demand, monthly median home prices have  skyrocketed over 77% since 2017.

Some developers believed that the solution to the housing market problem lay in the office building segment. The idea was that converting office buildings - left vacant by the pandemic - into apartment complexes would ease availability tightness. But in practice, the concept has proven inconsistent at the regional level,  gaining traction in New York but producing an  underwhelming outcome in Chicago.

The  Federal Reserve Bank of Atlanta recently identified the problem with the strategy; the physical layout of most office buildings makes them unsuitable for residential conversion.

Under these circumstances, the best thing you can do to get an edge in the residential market is to wait and prepare.

Time is On Your Side  

The American housing market may not heat up soon, but its resurgence is inevitable.

Millennials,  America’s largest living generation, want to become homeowners. Generation Y represents  43% of the nation’s homebuyers in 2022, up from 37% in 2021. The group accelerated homebuying across the country because  of remote work opportunities and low-interest rates made living outside the big cities appealing. Although surging interest rates have dampened Millennial enthusiasm for home purchasing, the effect is temporary.

Increasing rent costs and a predicted  4.5 percent mortgage rate in 2023 have set the stage for a Millennial-led housing market rebound.  

In addition, the labor shortage that has constrained residential development has loosened. Bloomberg noted the slowdown of the housing market had enabled builders to bring their payrolls to their highest level in 15 years. Once home purchasing demand picks up again, construction companies will be ready to start breaking new ground.

For developers, capitalizing on the long-term opportunity offered by the housing market requires meticulous planning and robust analytics. Converting a skyscraper into an urban luxury apartment complex could be a major revenue generator, but only with the right building and city. Launching a complex multifamily project in a  Millennial-friendly region could be hugely successful.

In the modern landscape, you need granular insights into every phase of the development lifecycle. Having access to in-depth property transaction data, underwriting, valuations, and demand growth forecasts is mission-critical in an era of economic uncertainty.

Download our 4 Recession-Proof Asset Classes white paper to learn how to identify lucrative development opportunities during an economic downturn.