Mortgage applications are already down nearly 40 percent year-over-year, and people are apparently in a wait-and-see or pause mode.
Home builder confidence fell for the 10th straight month in October, reaching a 10-year low (except for the start of the pandemic), according to the National Association of Home Builders.
The association said the flow of potential buyers, one component of measuring confidence, dropped significantly as buyers look for mortgage rates above 7 percent.
Real estate developers' cancellation rates are also on the rise, Lovallo noted. KB Home reported a 35 percent cancellation rate in the third quarter, up from 9 percent a year ago.
Lennar said 21 percent of orders were canceled, while Meritage Homes reported a 30 percent cancellation rate. Ali Wolf, chief economist at Zonda Research, tweeted Thursday afternoon that her data showed a 70 percent cancellation rate for builders in Phoenix.
Being able to move into a home within 30 to 60 days helps buyers when rates rise, especially since building a home to order can take six to nine months.
As a result, builders have had to get more creative with incentives, including rate locks, rate reductions and upgrades to kitchen appliances, Lovallo said.
Is this working?" We're starting to see some demand elasticity, which is encouraging," Lovallo said." There is still plenty of pent-up housing demand out there."
While homebuilders are struggling, larger builders are "in a better position," he says, and builders like D.R. Horton have better economies of scale." He says, "They will be able to buy commodities in bulk [and] access the capital markets." As a result, larger builders are definitely in a better position."
In addition, builders who offer spec homes built ahead of order or homes that first-time buyers can move into quickly can better "compete with the existing inventory on the market," he says.
Being able to move into a home within 30 to 60 days also helps buyers when interest rates look like they will continue to rise. Building a home to order can take six to nine months. However, builders are also having to deal with large backlogs and need to move inventory quickly.
Some builders are offloading inventory to agencies, which in turn are putting those units on the rental market." The rent-to-own market will become increasingly important," Lovallo said. While it won't overtake the for-sale market, he noted, it "does expand the range of buyers."
Homebuilder stocks trade at a fraction of book value, about five times earnings, Lovallo said.
Lovallo told Marketweek that it's time for homebuilders to explore some innovations. Since the 2008 recession, he said, "fewer and fewer homes have been built in the last 14 years," and "the homes that were built were built at high prices because that's where the demand was."
"The homebuilding industry is still building homes today the way they were built 100 years ago. They're making frames on site with sticks and lumber is being thrown around," Lovallo said." It's probably the only industry that hasn't had an infusion of technology in the last 100 years."
He adds that restrictions on labor and bureaucratic red tape related to land and permits have bogged down the process of building homes.
'The homebuilding industry today is still building homes the way they were built 100 years ago.
"There has to be some kind of change brought to the industry," Lovallo says." But I think 10 years from now, we'll be building homes much differently than we do today."
Even if builders see an increase in cancellations, buyers shouldn't expect home prices to drop significantly, Lovallo advised.
Unlike 2008, when home prices fell 30 percent during the global financial crisis, Lovallo expects home prices to remain relatively stable. Other analysts, however, are predicting a sharp peak-to-trough decline in home prices.
In an Oct. 28 note, Lovallo wrote that because people will likely continue to work from home for the "foreseeable future," home price appreciation may not drop significantly unless there is an external economic shock.
