Q3 Real Estate Market Update — Winter Is Coming (Part 2)

We continue to look at the housing market shift this week. Last week we covered the impact that rising rates, shrinking affordability, and increasing supply of homes are having on the market. We specifically covered some fundamentals that make certain geographic areas more vulnerable to a crash than others.

Today, we will look at three other elements that impact the housing market and the current developments taking place.

Housing Starts

Housing starts are a leading indicator of housing inventory that will be available in an anticipated time frame. In an environment such as we have had for a few years, where inventory is at a premium, new housing starts have been welcome news anywhere they are happening.

Unfortunately, as the market has shifted, so have housing starts. As of the last report from the U.S. Census, housing starts fell by 19% year over year in Sept 2022. Considering that just six months ago, housing starts were up 10% from the previous year, a 29% swing in new construction starts is a VERY significant shift.

The important part, aside from the fact that we now are expecting less homes to be built by a significant amount, is, why? Why the reversal of direction in new construction? As it turns out, homebuilder confidence is in the dumps! As a matter of fact, builders in some areas are so concerned about the outlook of the Real Estate market that they are starting to firesale their existing inventory.

There are multiple states across the nation where a significant percentage of homes for sale inventory comes from new construction as builders are trying to offload a backlog of homes built. Some of the states where new construction homes take up the largest percentage of homes for sale are:

State% of homes for sale that are new construction
North Carolina41%
Source Carolina38%

These states also happen to be where the demand for housing has had significant declines. In many areas, builders are now seen offering large incentives to buyers to purchase their homes.

Builders know the housing industry better than the average person on the street. If they are running scared, we should also be concerned, not just because builders are concerned, but because of the fundamentals leading to this concern. As we covered in Part 1 of our market update, rapidly rising rates, and shrinking affordability are taking a huge toll on the real estate market. And we are just starting to see the impact of this shift.

While some areas of the country are still experiencing shortages of inventory, some other areas are about to face a glut of homes for sale amid shrinking demand and affordability.

Price-to-Earnings Ratio

Another indicator of where the housing market is showing signs of stress is areas where there is a significantly high price-to-earnings ratio. That is a measure of how much prices are compared to how much the local workers earn in the economy. This is a great indicator of where the bubbles are. Let’s take a look at some areas that are in a very precarious position right now:

Phoenix: Going back 15 years and looking at price-to-earnings ratio, we see that in 2007 the typical home value was $273,000 while the average worker earnings were $34,000. Back then, prices were 8X earnings. After the crash of 07-08, the price-to-earning ratio went down to 4.2%. In 2011 prices were $134,000 compared to average earnings of $31,800 – 2014-2019 PE ratio settled at about 5.5 price-to-earnings which is a “fairly valued” market.

Today in Phoenix, we are back to 7.3 times the price-to-earnings ratio. The average per-capita income is $65K, and the average home price is $470K. Phoenix is in a similar bubble today than it was in 2007.

Miami: This is another city where the price-to-earnings ratio is rather disproportionate as well. The average household income in Miami is $44,500 compared to the average home price of $610,000. That average home price is 13.7 times the average household income in the area. Miami has the highest PTE ratio city in the nation.

St. Petersburg is also a city in Florida but with a vastly different story than Miami. In St. Petersburg, the average home price is just $390,000, while the average household income is a nice $65,054. The PTE ratio here is just 5.6.

Cities where the average price-to-earnings ratio for housing is above 7, are highly likely to experience a significant drop in home values, especially if there are other economic factors that contribute to a decrease in local housing demand.

But there is more!..

Job Growth

The last but not least contributor to housing is job growth. Right now, that is a bright spot in our nation’s economy. At 3.5%, we have the lowest unemployment rate in the last 40 years. If the low unemployment rate continues, the impending housing correction may not be as bad as it is projected.

However, we still have the “R” word to deal with…the “Recession” and it’s impact on employment. Depending on your news source, you probably have already been informed that we are officially in a recession. The impact has not been felt in the employment sector, but we are at the early stages still. The holiday season is upon us when many businesses make the bulk of their revenue for the year. They have been hiring at a brisk pace in anticipation of a profitable last quarter. We will be back again with another update in early January, and we shall see how the Real Estate market and the economy have fared by year’s end.

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