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This is a concept page on New Home Construction. Click to view the Residential Construction industry page.
New home construction is a surprisingly complicated process that affects many different companies and industries. As such, increases or decreases in the number of new homes built can have far-reaching effects throughout the economy. The construction of a home requires a wide variety of raw materials, such as lumber, brick, cement, etc. After construction, new homes also require myriad furnishings, appliances, and accessories, further spreading residential construction's impact to other industries. Additionally, new home construction is not just a onetime expense. Maintenance, renovations, and the purchase of related goods and services extend the impact of new residential construction into the future, providing a long-term source of demand for a number of different industries.
New home construction is an excellent indicator of the health of the overall housing market. Essentially a function of housing demand, increases or decreases in the number of new homes being built are largely reflections of occurrences in the housing market and beyond. Events that lead to lower demand in the housing market will also negatively impact new home construction, while positive forces that increase demand for housing will lead to more residential construction.
The rate of residential construction is determined by conditions in the housing market. Strong demand in the housing market will stimulate new construction as housing inventories dip. Conversely, weak housing demand or an oversupply of homes can cause real estate developers to scale back significantly on new construction until market conditions improve. As such, many of the factors that impact the housing market as a whole also impact the rate at which new homes are built.
Housing inventories include all homes listed for sale in a given area, both new and used. Changes in housing inventories, in addition to serving as a good indicator of the state of the housing market, can impact new home construction drastically. Rising inventories of homes for sale indicates that people are buying fewer homes than they previously did. This oversupply of available housing would likely decrease new home construction until inventories begin to fall. Falling inventories can stimulate new home construction, as they imply an increase in housing demand.
Interest rates can dramatically impact the housing market and, therefore, new home construction. When interest rates either rise or fall, the economy as a whole is affected. The housing market and new home construction, however, are particularly sensitive to these changes for a number of reasons.
As interest rates increase, it becomes more expensive to obtain a mortgage on a home. Given mortgages' generally long terms (usually 15 or 30 years), even small changes in interest rates can significantly impact monthly payments and the total cost of buying a new home. Higher interest rates are likely to cause a decrease in demand for housing due to these rising costs, which, in turn, decreases demand for new home construction. Conversely, lower interest rates can make borrowing money cheaper and increase demand for new residential construction.
Increasing interest rates can also harm preexisting mortgages and result in higher foreclosure rates, increasing the supply of homes on the market just as it becomes more expensive to buy them. The reason for this is the adjustable-rate mortgage, or ARM. ARMs are different from fixed-rate mortgages in that the interest rate is variable, changing with current interest rates throughout the term of the mortgage. These ARMs became very popular in the early- to mid-2000s, when low introductory, or "teaser", rates caused many people to take out ARMs and buy houses. After the introductory period, however, the rates on these ARMs were reset to reflect current interest rates, resulting in much higher monthly payments. As a large percentage of these ARMs were made to subprime borrowers, many of whom could not afford the higher monthly payments, increasing numbers of homes began being repossessed. As many ARMs are still in their introductory periods, future waves of rate resets could further increase foreclosure rates. Interest rate increases could further exacerbate the problem, causing even more consumers to default on their mortgages. This increased number of foreclosures could lead to rising inventories of homes for sale, reducing demand for new residential construction.