Dave:
Hey, everyone. Welcome to On The Market. I’m your host, Dave Meyer. And today we are going to talk about one of the most common questions I get about the housing market and one of the most commonly misunderstood elements of the housing market and the entire investing landscape, and that is the new construction market. Because often, and I am definitely guilty of this, we talk about the “housing market” as if it’s just this one big thing and everything in the entire national housing market moves in one direction. But if you’re experienced with real estate or you listen to this show, you know that that’s not true.
When I talk about the ‘housing market,” I’m talking about the national housing market, but of course there are regional markets. We’re seeing that play out a lot right now where super expensive unaffordable markets like Boise or Austin are starting to see price retreats, whereas other markets like Chicago or Boston are still doing pretty well. So that’s one way that the national housing market is segmented. It can be national, it can be regional. But the other one that is not talked about as much, at least on this show and in other media outlets that I listen to, is the difference between the new construction market and the existing homes market. And just to be clear, hopefully this is self-evident, but new construction is just houses that are built and people buy them for the first time. Existing homes is a home that is already owned by a homeowner or potentially another investor, and they are reselling it.
So these are the two different markets, there’s new construction and there’s existing homes that we’re talking about today. And there have always been different dynamics in these two markets, but as we enter this new phase of the housing market, I personally think it’s a correction that we’re entering. I think it’s important to understand how these two markets are different. And normally on the show when we generally talk about the housing market, we’re talking about these existing home sales because this is where most people operate, right? Most investors, most flippers, most wholesalers, and even short term rental and buy and hold investors mostly operate in this existing home sale. So that’s why we talk about it most of the time. But new construction has huge implications. Not just for the housing market and for individual investments, but it also has a huge impact on GDP like the entire US economy and it even has an impact on renters. So we want to talk about this to help you understand where the housing market in general is going. So we’re going to zoom in on this new construction question today and fill you in.
The other thing I just want you to take note of is that over the next couple of weeks, we are going to have some shows where we’re bringing in some guests, some builders, some developers to talk about the current market conditions. And they’re going to be incredible shows. These are super experienced, really cool people. But I wanted to give you a background on the new construction market so that when you listen to these episodes over the next couple of weeks, you have a good understanding of what’s happening and some sort of the dynamics in the new construction market. So that’s what we’re going to talk about today. Super excited. I think this is going to be really eyeopening for people to see the differences and how these two markets work. So definitely stick around for it. We’re going to jump right in, but first we’re going to take a quick break.
First up today, when we’re looking at the new construction market, let’s just look at where we are today. Then I’m going to dive into some of the background context and explain the three things, the three main takeaways that I have seen based on the dynamics of the new home market. So the first thing is as of July 2022, we’ve seen that the media new home price, so new construction fresh off the lot is $440,000. And that’s come down a little bit. It actually peaked back in April and it is down 4% off of its April high, which is pretty significant, but it’s still up year over year. So compared to last July, it’s still up 8%.
And that sort of mimics the dynamic that we are seeing in the existing home market. But the existing home market is much less expensive. So it’s about $400,000 in July. So about 10% less than new homes. And although existing homes are coming off their high, existing homes are only down about 2.5%, whereas new homes are down about 4%. So we’re already seeing that new homes, they are coming down off their highs faster than existing homes. And this is not super surprising. This is typically what happens. And the main reason it is happening is because the volume of sales is going down. Just fewer people, fewer home buyers out there want to buy new construction. And that’s probably because it’s more expensive, right?
I just told you it’s about at least 10% more expensive to buy a new home. And so we’re seeing the volume, the total amount of home sales really come down. It was at about 830,000 back in January, and now it is at 500,000. So that is a huge reduction in the number of people who want those homes. That means there is less demand. And as we’ve been talking about all year, when demand drops off, that’s when prices start to fall. And that’s exactly what we’re seeing, 4% off of its high.
Builders are also understanding that there is a lack of demand. In August, almost 20% of builders said that they’re starting to slash prices and they’re offering incentives. So this is a big departure from where we were a couple months ago where people were lining up out the door to get their name on a wait list just for new construction. People were moving into things that didn’t even have garage doors. It was crazy. Now the situation has entirely flipped and it’s much, much more of a buyer’s market to the point where back in August, 20% of builders were offering incentives to buyers. They’re offering discounts to get people into these homes. And as we’ll see over the course of this episode, it’s probably just the beginning of that dynamic.
But if you’re thinking that this is going to be terrible for builders, they’re all going to go out of business and we’re going to see something like we saw at the end of the great recession, that is probably not true. So John Burns, who was on this show a couple weeks ago, his company did some awesome research and showed that prices for new construction can actually come down 8% and still make their historical margins. Things for builders and for developers have been so good over the last couple of months that they could drop prices for their houses 8% and they could still make just as much as money as they used to prior to the pandemic. So if you think this could be a cascading effect, it could, but not yet because builders have a lot of cushion in their margins.
You know how we always talk, James always talks on the show about how you want to add cushion to your margins. Well, builders have been doing that. They have excellent margins right now, and they can see home prices come down really significantly, 8%, without them really even impacting what they would normally expect in years like 2018, 2019 and before all of that. So we are seeing demand drop. And the consequence of that so far is that prices are starting to drop. I personally think prices are going to drop even more than the 4% that they have. I think with new construction, we’re going to see it go down at least 8% and maybe a little bit more, but we’ll see.
But the other thing that you have to understand about where we are now is that when demand drops and prices drop, so does construction. I mean, if you were a builder and you were seeing less demand, you were seeing worse margins, you’d probably stop buying too, right? And so there is this index, it’s called the National Association of Home Builders, this big trade organization. And what they do is they survey some of the biggest bu
ilders in the country every single month for their sentiment, because that is a great lead indicator. So we talk about on the show quite a lot, we want to look at lead indicators. It helps us understand what might come next. Nothing predicts the future perfectly, but it helps us understand sort of where things are going.
This National Association of Home Builders sentiment index has fallen seven months in a row. Every single month over the course of 2022, we have seen this index decline and it is at a very low point right now. Relatively, it’s at about 50. Last year, we were above 80, above 90. And so previously, builders were feeling great. We were in this low interest rate environment and everything was awesome. And now just like everything else, we’re seeing interest rates go up, affordability is declining. And because new homes are more expensive than existing homes, they are getting hurt hardest by the lack of affordability and we are starting to see builder sentiment go down, which is sort of naturally. This means that construction is starting to slow. We’re actually already starting to see construction slow a bit. It’s come down off of its high, and we’re going to get into some of the details of that in a little bit. But that’s significant for the economy because when construction slows, it slows down a lot of other things in the economy.
So overall, that’s where we are right now. We are starting to see demand fall off in a very significant way for new homes. We are seeing inventory start to tick up, prices start to go down. So that doesn’t bode well for new construction, right? Prices are coming down. Not a lot of people want it. And as a result, construction is likely to slow. We’re seeing builders start to offer incentives. And we are seeing that new home market is decelerating and even going negative faster than the existing home sale market.
Now, it’s important to point out that new construction is only about 11% of the total market. So it’s not like this is going to drive the entire housing market, but as I’m going to show over the rest of this episode, there are three things that really are impacted by this slowdown in new construction and they have long lasting implications for the whole housing market. Not just the new housing market. But for everything that investors need to be thinking about, there’s these three big implications. So I’m going to jump into those.
The first implication for current market conditions in the new home market is the housing shortage. Now, you might have heard over the last couple of years that there is a housing shortage in the United States. The estimates for how big the housing shortage is very pretty widely. On the low end, you see people like Moody’s Analytics and they think it’s about one and a half million. On the high end, we have NAR, the National Association of Realtors, they think it’s about 7 million. Freddie Mac is right in between about 5 million. So either way, I think almost every analytics organization that can track these kinds of things believes that we have a housing shortage in the United States. And that’s a problem. That is one of the reason why home prices have been going up. It’s why rents have been going up because when there’s not enough supply, that pushes prices up.
And of course, the reason we have a home shortage is not enough homes have been built. And I know that’s probably pretty obvious, but that’s sort of what happened. Let me just quickly provide a little history lesson about what happened since the great recession. See, construction has basically been on this roller coaster since the turn of the century. When I look at the total number of units under construction, you see that it’s very, very sensitive to economic cycles. So when demand is up, builders build. When demand shrinks, they stop building. And we see this pattern going back basically to every single recession in the 1960s.
This is again a great lead indicator. We see new construction start to drop off before we’re even in a recession. And of course, right now we don’t know if we’re in a recession, but we are starting to see construction drop off. So it’s another indicator that we’re probably in a recession or close to a recession. But basically what’s going on is that when you see a slow down economic activity, you see a downward trend in construction. And this normally happens. It’s a normal thing. Economies and the housing market are very cyclical. But in the great recession, things were way worse. It was sort of this overcompensation. We saw a decline in economic activity. And the corresponding decline in construction was way more than it ever has, right? Normally in a recession, construction goes down, we build less units, but it’s not like we build nothing. That’s sort of what happened in a great recession.
Back in January of 2006, we were building 1.3 million units on an annualized rate, excuse me, 2.3 million units. In April of 2009, about three years later, we were down to under 500,000, right? We went from 2.3 million to under 500,000. That’s like about 20%. We dropped 80% off, which is crazy just in three years. And this entire industry, the entire construction industry was gutted. People change jobs. If you’re not building, you go find another job. Building, construction companies just completely went out of business. This happened in the late 2000s, 2010, and then 2011.
And then starting in mid 2011, construction started to pick up again, but it was really slow, right? All these people left their jobs, construction companies went out of business. You can’t just snap and turn things back on. We’ve all sort of learned this lesson from COVID that when these machines of production slow down and people change jobs and they do something else, you can’t just fire it back up again. And so that’s sort of what happened with construction in the 2010s.
And luckily, over the course of the 2010s, we were getting pretty close to historical averages. We were at about 1.7 million, which is still by the way I should mention, even at 1.7 million pre pandemic, that’s way below where it was in the 2000s bubble. But in the last years, it’s gone up and we’ve started to build more and more and more. And now we reached 1.8 million in April 2022, which was great because we were starting to sort of erase some of the housing shortage. But now it’s starting to come back down and we’re at 1.4 million as of August, which is sort of the rate we were back in the 1990s.
And so this is basically a problem for the long term housing supply in the US. Now, I think it’s right, that construction is coming down right now because you don’t want to flood the market with new units when demand is low, because that means there’s going to be units sitting vacant and the prices are going to come down and that process its own problem. But to erase the housing shortage, whether it’s 1.5 million units or it’s 7 million units, we need to be building above the immediate demand to start cutting into that deficit that we’ve had, right?
Just like in COVID, basically it’s like if you shut down a factory and nothing’s being produced, let’s say it’s cars and you shut down a factory and no cars are being made, but we were still allowing people to make orders, right? That’s basically what happened in the US. People were still forming families. They still wanted homes, but we weren’t building enough of them. And so there’s this backlog and we’re behind. And if construction comes down for an extended period of time, that means that we could see the housing shortage prolonged in the US.
So that’s, I think, an issue long term, because personally, I think this is just an opinion, it’s not a fact, I believe that the levels of affordability that we’re at in the US are not good for people, right? It’s too expensive for people to buy a home. It’s pushing up rent prices to the point where people can’t afford it. And that might sound good for rental property investors, bu
t I don’t believe that to be true. I personally prefer a very stable housing market where things go up around the cost of inflation, maybe a bit more, rent grows gradually, and we’re not seeing these wild fluctuations right now. And so I believe the US needs more housing supply. That is the solution to these wild swings in the housing market. It’s the solution to the affordability problems that we’re having. And unfortunately, given market conditions, construction is likely going to slow.
Now, there is one encouraging fact that we’re seeing here is that although construction starts are starting to go down, single families are down a lot. They’re down 16% year over year. So builders don’t want to build single families. But multifamily is still up. So that’s pretty good when we talk about the overall housing supply, that people still largely, myself included, believe in the long term viability of multifamily investing. And so, although it’s slowing down, builders are still building that. One reason is because there’s more margin for error with multifamily. And the second is it takes a long time to build multifamily. So if it takes three years to build a new apartment complex from entitlement, permitting, building all this lease out, all these things, maybe they’re foreseeing that we’ll be in a different economic cycle, things will start be growing again three years from now. Not a bad bet.
So I think that’s encouraging for the housing shortage, but it’s something to look at. So that’s my number one takeaway, is that for now it’s unlikely we’re going to see a lot of progress in increasing the total amount of housing in the US. And that puts upward pressure on the housing market over the future. As long as we are under supply, there will be this undercurrent of upward pressure on housing prices even all other things considered, right? So that’s just something to consider. That’s number one.
The second thing that I think you should take away from this marketing conditions is that economic activity is really driven by construction to a really remarkable amount. So there is this study again by the National Association of Home Builders that shows that housing’s combined contribution generally contributes 15 to 18% of GDP. That is huge. And so 15 to 18% of the entire country’s economy is depending on housing.
They actually broke it out in two ways, which I think is super cool. The first is residential investment. So this is 3 to 5% of GDP, which basically includes construction. So this is construction of single family residences, multifamily, remodeling, manufactured homes, brokers fees. So this is basically the building and selling of new houses and major renovations. So that’s 3 to 5% of GDP. And so we’re starting to see that decline and that could impact GDP. Another indication that we could be heading towards a recession or might already be in one is because construction is slowing down and it is such a major driver of GDP. That is something to consider.
The second way that housing contributes to GDP is consumption on housing services. So this is rent and utilities and that sort of stuff. And personally, I don’t think that’s going to be going down as much. If we do enter a major job loss recession, we could see that slow down, but for now in the purposes of this episode, I really just want to point out that residential construction is probably going to come down. Rent even in recessions usually doesn’t come down very much. Maybe a little bit, but not as much as housing prices might. And so that is something to consider, is that if you are concerned about a recession, about job losses, that sort of stuff, construction is going down, and that could bring other sort of tangential parts of the economy down with it. I’m not talking about a crash. We’re talking about a couple percentage points. But there could be some construction related job loss. And some of the other industries that surround construction could see sort of this ricochet domino effect thing.
The third thing… So the first thing again was the housing shortage. Second thing is GDP. And the third sort of speculation on my part, but I wanted to bring it up because it’s something I’m sort of interested in, and that’s existing home prices. So this is anecdotal, again not scientific, but over the course of history there has been this spread between the pricing of new construction and existing homes. And previously, it could be up to 30%. Sometimes it’s about 20%. But recently back in 2018, it was about 25%. So if you were going to buy the median new home, it was about 25% more expensive than the median existing home. And that’s pretty significant. 25% is a lot, right? That’s the difference between a 400,000 and a $500,000 house. So they’re less expensive to maintain. So that’s good, but you have a bigger down payment, that sort of thing. So that’s a big premium.
But the spread between new and existing homes has really, really compressed over the last couple of years. And that’s happened for a few reasons mostly because there’s just not a lot of inventory for existing homes, and so existing home prices have gone up. But all things being equal, new construction tends to be better, right? At least for me, if I was buying a three bed, two bath house that was 2,000 square feet in the suburbs and they’re both similar houses, I’d choose the new one, right? It’s probably better, building quality, new materials, things that aren’t used, they’re in better condition. But right now the premium is pretty small. So it’s like there’s only an 8% premium right now. It used to be about 25% more expensive to buy a new house. Now it’s only 8%. And we’re starting to see these concessions come in.
And so this is just my theory, but as new home prices start to come down, it might suck some of the demand out of existing home sales, right? Because if builders are offering these incentives and you can get a new home for very little more than an existing home, that could suck some demand on the existing home market and have existing home prices fall a little bit more than they used to be. So I don’t know if that’s true. This is just sort of a theory. It’s not a dynamic that I’ve actually seen before where we’ve seen new home prices so close to existing homes. So that’s something to keep an eye out for. Again, it’s not scientific. This is just my personal opinion and something that I’m kind of interested in.
So that’s what I got for you today. Hopefully this is a useful background for you. Just to summarize what’s going on, new home sales, existing home sales, very different markets. Traditionally, what happens in one doesn’t necessarily happen in the other. And we’re already starting to see that prices, the new home market are falling faster. Inventory shooting up a lot faster. And we’re starting to see a correction there more quickly than in the existing home sales market. This has huge implications for the economy because construction is a major driver of jobs and GDP. It’s important for the long term supply for US housing because when construction stops, it further exacerbates the housing supply shortage that we have in the United States and it could bleed into the existing home sales market. Now, existing home sales are also coming off their peak, but I think what happens with these two markets, they’re going to interplay in a unique way that we’ve never seen before. And it’s something to keep an eye out for.
Hopefully this is useful background for you because over the next couple of weeks, as I said at the top of the show, we are going to have some new people, some builders, some developers talk about the state of the construction industry. And I want you to understand, even if you don’t buy existing homes, why this is important and why it matters for investors. Even people who only rehab homes or buy existing home sales, I want you to understand that what happens with builders, what happens with developers and in the new home
sales market does impact the entire housing market and is super important.
Thank you all so much for listening. I always appreciate you giving us feedback. If you want to do that on YouTube, it’s a great place to do that. You can also hit me up on Instagram where I am @thedatadeli. And if you like this episode or just love On The Market, we really, really appreciate if you give us a five star review on either Spotify or Apple. It’s a huge help. Thanks again for listening. And we’ll see you again next time On The Market.
On The Market is created by me, Dave Meyer, and Kailyn Bennett, produced by Kailyn Bennett, editing by Joel Ascarza and Onyx Media, copywriting by Nate Weintraub. And a very special thanks to the entire BiggerPockets team. The content on the show On The Market are opinions only. All listeners should independently verify data points, opinions, and investment strategies.