Citi warns housing construction weakness likely to persist as rates remain high

U.S. housing starts and permits saw a modest June increase but remain near multi-year lows, according to a recent Citi research note. The report indicates June's strength was concentrated in multi-family units, masking continued weakness in single-family construction, even as overall activity returned to pre-pandemic levels. Citi attributes this persistent softness to restrictive interest rates and normalized existing home listings, forecasting continued weakness in new construction.

Analysis

A recent Citigroup analysis indicates a fragile U.S. housing market, where a modest increase in June housing starts is overshadowed by significant underlying weakness. The headline figure is misleadingly supported by volatile multi-family unit construction, masking a persistent downturn in the single-family home segment. This softness persists despite overall housing activity returning to pre-pandemic levels. Citi attributes the weakness primarily to restrictive interest rates, which are dampening housing demand. Furthermore, the supply-side dynamics have shifted; with listings for existing homes now back at pre-pandemic levels, a key incentive for buyers to turn to new construction has dissipated. Consequently, Citi forecasts that "weakness in new construction will likely continue." The Vanguard Real Estate ETF (VNQ), a sector benchmark, reflects this challenging environment with a modest P/E ratio of 12.05, although it offers a robust 3.87% dividend yield, which has been consistently paid for 22 consecutive years.

Key Decisions for Investors

• Investors should exercise caution with exposure to residential construction, particularly single-family home builders, given the forecast for continued weakness driven by restrictive interest rates and normalized housing supply.
• Monitor key leading indicators such as mortgage application rates and Federal Reserve communications on interest rate policy, as these are the primary factors influencing the sector's direction.
• For income-oriented portfolios, the Vanguard Real Estate ETF (VNQ) could be considered for its historically consistent and robust 3.87% dividend yield, which may provide a partial buffer against potential price weakness in the sector.