Will the housing supply gap ever close? 

Despite the highest number of housing completions in a decade, supply continues to lag behind household formation, according to a new report from Realtor.com.

"What's really going to move the needle is getting buyers back into the market," said Realtor.com Economic Data Analyst Hannah Jones, author of the report. 

And that's going to require improved affordability, either through wage growth or reduced mortgage rates. "While the government is trying to get inflation down, mortgage rates will have a firm floor under them," Jones said. "It's going to be a bit of a standoff for the time being as the larger issue of inflation weighs on the economy."

Indeed, Jones says a brief dip in mortgage rates in December and January sent builder confidence soaring after 12 straight months of decline, only to crash back to earth when rates ticked back up.

New homes began to take off in 2021, stalled in 2022

After more than a decade of under-building, housing starts and completions rebounded to their highest numbers in ten years in the second half of 2021, as low interest rates brought buyers flocking to the market.

But a year later, builders started tapping the brakes on new starts in response to rising interest rates, according to the report.

So while housing completions rose, starts fell by 10.6% from 2021 levels. Because of the lag between starting construction and putting a home on the market, the impacts on inventory will be felt this year.

At the same time, household formations climbed, reaching a record high in December 2022.

While 2022's one million single-family home starts represented the highest annual number since 2012, it was dwarfed by the more than two million new household formations. The gap between homes and households continues to keep inventory tight and hamper affordability.

Builders shift to multifamily; single-family supply lags

Record-high rents led builders to pivot toward multifamily housing, as builders saw homebuyers exit the market due to rising interest rates. But that additional multifamily supply won't help affordability in the for-sale market, according to the report.

Construction of homes with two or more units was 29.6% of all housing starts in 2021 and grew to 35.1% by the end of 2022. Because the typical multifamily home takes 15 months to complete versus seven months for a single-family home, those multifamily units will hit the market over the next year, potentially providing more relief for the rental market.

Affordability still key

Renters may have reason for optimism, but for buyers, the double whammy of higher interest rates and low supply have resulted in a challenging market. The report noted that rising rates and home prices have bumped up the cost of a typical mortgage by close to $650 over the past year — nearly a 50% increase. 

Just 10% of new homes sold for less than $300,000 in the last quarter of 2022, down from 41% in the fourth quarter of 2019, pushing some would-be buyers out of the market altogether.

That, in turn, has builders concerned they won't be able to find buyers for single-family homes, even as the housing gap continues to grow. It's at least partly a self-perpetuating cycle, Jones acknowledged, as reduced inventory keeps prices high.

At the current rate, the housing gap will never close, the report said. The rate of single-family housing starts would need to triple to close the gap in three to four years. If total starts are considered, a 50% increase would close the housing gap in just two to three years.

But that's a pace of construction last seen consistently in the early 1970s, and sporadically in the early 2000s.

Jones said that while the market is at something of a stalemate, eventually it will break. "There's just so much pent up demand in the market," she said. "If we see mortgage rates come down, we'll see that demand coming back into the market. While I don't know when that will happen, anything that improves affordability will bring buyers who are just on the border into the market again."