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Downturns are challenging, but cycles are inevitable. Be agile and adapt as we approach the next housing cycle. | Image: ArtemSam /
This article first appeared in the July/August 2022 issue of Pro Builder.

There’s turbulence in the housing market. Rising mortgage interest rates are destined to go higher to fend off overall inflation, putting more potential homebuyers on the sidelines and increasing contract cancellation rates.

With that, new-home prices remain at record-high levels, also causing homebuyers to hesitate—either because they can’t afford to buy, don’t want to buy at what they think may be the peak, or they know they’ll suffer a higher interest rate (perhaps double their current rate) on a new purchase. In any case, sitting on the sidelines keeps them from selling their current home, thus further reducing overall housing inventory in a market characterized by hyper-demand.

It’s a cycle that makes housing less and less affordable, especially for first-time buyers. I remember buying my first home and how the monthly payment was a significant determining factor of how much (if any) home I could afford. The same is true now, even with mortgage rates still low by historical comparison.

The Housing Price – Mortgage Rate Dynamic

Home prices and mortgage rates go hand in hand; you can’t fully evaluate one without considering the other. Higher mortgage rates mean higher monthly payments, which shrinks the pool of potential homebuyers. We can have historically high home prices if mortgage rates are historically low and still enjoy an active market, but when both are on the rise, demand slows.

Mortgage rates also affect housing supply and demand in a different way. As rates rise, contract cancellations and unsold spec inventory increase the supply of new homes available for sale, tempering prices and boosting affordability, which, in turn, boosts demand. At least that’s the theory (and the track record) in our industry.


Is There Really a Housing Supply Issue?

Some folks who are overly bullish on housing are quick to point out that the U.S. has a housing supply deficit. You could argue that, but it really doesn’t matter whether we have a housing shortage or not if affordability concerns are keeping many potential buyers stuck on the sidelines, unable to afford a home, which is the sad reality.

While I don’t feel especially bullish about our current place in the housing cycle, I’m also not one of those doomsday YouTubers who predict an ocean of foreclosures in our near future, and certainly not on the scale of what we experienced during the depths of the Great Recession.

Foreclosures will indeed increase slightly from their near historic lows thanks to other economic factors (overall inflation being one of them), but people have more options to fend off foreclosure than they did during the Great Recession; most have equity in their homes that’s not driven by speculation or risky loans and they have the option to sell to a hungry market ... and, in turn, increase supply.

Controlling Housing Costs With Spec Homes

Another item that will affect housing supply is the significant amount of new-home inventory under construction that has yet to be offered for sale.

That’s because many builders started more spec homes than usual as a hedge against rising materials costs and supply uncertainty, instead of being forced to ask buyers for an inflationary increase in the price of their new homes or eating the increase themselves.

By waiting until these spec homes were substantially complet­ed—or at least were through the framing stage—before offering them for sale, builders were able to better un­derstand and manage their costs.

A lot of that new-­home inventory will hit the market during the second half of this year, helping to close the supply gap, ease affordability, and somewhat counter the impact of higher interest rates on demand.

Why Home Builders Need to Have a Plan B

So, what are you as a home builder going to do during this transitional time? Prepare.

Think about it: Even if I’m wrong and the market continues to go up and up from here instead of easing off a bit, wouldn’t it be wise to have a Plan B? (Personally, I like hav­ing a Plan C, too.)

One of the best ways to prepare for a market shift is to engage your most strategic resources; that is, your team. Start by asking them to answer the follow­ing three questions, as they relate to a 20% to 30% drop in the market, specifically:

1. What should we start doing now to prepare?

2. What should we continue doing even if the market corrects?

3. What should we stop doing if the mar­ket corrects?

Consider setting up cross­-functional teams to develop ideas that span depart­ments. Look for ways to increase effic­iencies without sacrificing effectiveness. (It doesn’t matter how fast or efficient you are at doing something if you’re doing it wrong; chances are any time saved will be spent doing it over.) Watch your expenses. Maintain a cash balance. Focus on improv­ing your competitive advantage. Finally, look for the positives in everything.

Downturns are challenging, but cycles are inevitable. Be agile and adapt as we ap­proach the next housing cycle.