Vanguard research

U.S. housing: Cyclical weakness, structural strength

June 08, 2023

New Vanguard research identifies three drivers likely to support the U.S. housing market. This first of three articles highlights one of the drivers: the undersupply of homes in the U.S. “In this economic cycle, we expect housing to become a stabilizing force rather than a further drag as in past cycles,” said Josh Hirt, a Vanguard senior economist and part of the team conducting the research. “The undersupply of homes, supportive demographic trends, and healthy borrower fundamentals are key structural areas of support for the market ahead.”

Supply has lagged for well over a decade

The 2007 subprime mortgage crisis brought on the sharpest downturn in the housing market since the Great Depression. While credit conditions were partly to blame, so was overbuilding in the years leading up to the crisis. Privately owned housing unit starts were running at a breakneck pace approaching nearly 2 million a year, according to the Federal Reserve. That contributed to a significant surplus in houses on the market in 2007, as the first chart shows.

Following that crisis, annual housing starts fell below 500,000, with dozens of home builders merging or going out of business and many laid-off construction workers exiting the industry. With those developments and an abundance of caution among surviving residential construction companies, the pace of construction really only ramped up again in the last several years. The result was an acute undersupply of available homes.

Years of underbuilding have contributed to a historically tight housing market

An area chart shows undersupply and oversupply expressed as houses for sale from January 1984 through December 2022. There was a notable period of oversupply in the mid-1980s and an even greater spike around the middle of the first decade of this century. In contrast, there has been significant undersupply more recently, especially in the last 3 years.

Notes: The oversupply/undersupply of homes is estimated as new and existing homes available for sale divided by total households relative to the long-run median.

Sources: Vanguard calculations, using data from the U.S. Census Bureau and the National Association of Realtors.

Homeowners’ reluctance to sell

More recently, supply has further been held back by a rapid rise in mortgage rates.

“We’ve seen almost a doubling in mortgage rates over the last 12 months, climbing from around 3% or 4% to closer to 6% or 6.5%,” said Ian Kresnak, a Vanguard investment strategist. “That’s created a pool of homeowners—about 90% of all homeowners by our calculations—who might be ready to move and have built-up equity given the sharp rise in housing prices since the pandemic, but don’t want to sell because they would lose the low financing costs they have locked in. That’s a supply headwind of a magnitude we haven’t seen since the late 1990s.”

90% of homeowners have mortgages well below current rates

An area chart shows the 6-month rolling forward average of outstanding mortgages as interest rates that are lower than current mortgage rates. The percentage was high at times in the 1990s, in the middle of the first decade of this century, and in 2022. It was relatively low in the early part of the first decade and in the early 2010s. The previous peak was reached in the summer of 2000.

Note: Figure shows the six-month rolling average percentage of current mortgages more than one percentage point below the prevailing 30-year conventional mortgage rate. One percentage point is used as a proxy for refinancing costs.

Sources: Vanguard calculations, using data from the Mortgage Bankers Association and Refinitiv.

What the undersupply could mean for the housing market

New construction starts have been trending higher in recent years, but a lack of workers, a dearth of available land, and a shortage of and higher prices for building materials have made a rapid rebuilding of supply challenging.

“With the Federal Reserve in the later stages of its rate-hiking cycle, we expect the worst of price decreases and sluggish sales and starts to be behind us,” Hirt said. “Recent data on home sales and starts are supporting this view, where we have seen what appears to be a bottoming already underway.”

"Even when interest rate volatility subsides, we expect that mortgage rates will remain elevated in a range around 5%, which will continue to act as a hurdle to supply,” Kresnak said. “However, we’ve estimated that tight supply will keep home prices from falling as much as they might have otherwise—to a 5% year-over-year decline at most—which could encourage more housing starts.”

That, along with supportive demographic trends and strong borrower fundamentals, should put housing on the path to becoming an economic stabilizer, with negative contributions to GDP since mid-2021 turning positive by 2024.