Housing CEOs Say Cost Relief is Ending

The Fed is forecasting overall core inflation to decelerate in a meaningful way in 2027, but residential construction costs are likely to rise faster

Over the next six months the most important dynamic for markets and the economy is about resolving the question of why the Federal Reserve raised interest rates last week. The Fed’s forecast assumes one more interest rate hike followed by core inflation slowing to 2.5% next year. That’s the bull case that stock markets are going with as well – that the Fed has a couple clean-up hikes to do, and then the coast is clear. It’s why the S&P 500 is already approaching all-time highs again. The underlying view is that inflation remains largely a function of supply shocks from tariffs and energy prices, and that the passage of time and a couple interest rate hikes will get us back on track.

This is where the signals coming from the housing industry are useful. From an inflation standpoint, the broad-based slump in housing over the past few years has helped the Fed accomplish its goals. Transaction activity, homebuilding, and apartment construction have all declined. High interest rates have kept homeowners from cashing out equity. Homebuilders, suppliers, and subcontractors have all sacrificed profit margins to sustain their businesses, which has kept a lid on pricing.

Lennar, the second-largest homebuilder in the US, quantified some of these dynamics in its earnings call last week. Using 2023 as a baseline, revenue per square foot is down 13%. At the same time, construction costs per square foot have declined 14%. That includes the past year, where construction costs per square foot are down 6%. Even though there’s been a lot of talk about how the AI boom has had a crowding-out effect on the economy, pushing up interest rates and memory prices and costs for some raw materials, until now we generally haven’t seen residential construction companies call out these pressures.

The issue is where we go from here. Stuart Miller, the Executive Chairman, CEO, and President of Lennar, spoke about how conditions are shifting. Speaking on the earnings call, he said “Labor availability has started to become more of an issue. Immigration enforcement and enthusiastic data center construction continue to create tightness in certain geographies. While we’ve been able to offset labor cost increases with efficiencies from scale, the pressure on cost is certainly building.”

Two large Sun Belt-centric apartment REITs spoke about these dynamics last week as well. At the Bank of America New York Global Real Estate Conference, Alex Jessett, the CEO of Camden Property Trust, said that construction costs are down 5-8%. But he said they’re not down in labor or commodities, but in profit margins for subcontractors. And he said there’s a limit to how much you can squeeze subcontractors, and that “we’re probably at the point where construction costs are the lowest that they’re going to go.”

Brad Hill, the President and CEO of Mid-America Apartment Communities, echoed those comments, saying “it’s hard to see that construction costs would continue to come down going forward, because you can only reduce margins so much.”

These comments give more credence to something a key supplier to the residential construction industry, Builders FirstSource, said on its earnings call in late July. Its CEO, Peter Jackson, said “We’re getting to a more predictable outcome on margins. I would say we’re not quite where we want to be yet, but it’s a lot more stable over the past six months than we’ve seen over the past few years.”

This brings us back to the Fed, their outlook, and how housing fits in. When the Fed was aggressively raising rates in 2022 they had a clear message about why they were doing it, and there was also a good theory about how it could work out for everyone. Inflation was too high and interest rates were too low – the Fed had to raise rates a lot to account for that. But it didn’t have to end in disaster for the economy. Fiscal stimulus was running out, supply chains were healing, and there was a framework, put out by Fed Governor Chris Waller, that since the level of job openings was so high, it was possible that job openings could fall to a more normalized level without leading to a lot of layoffs. Interest rate-sensitive industries like housing would get hurt in this process, but the economy as a whole could avoid recession.

Core inflation only got back down to 2.6%, and it took longer than expected – the first half of 2025 – but that benign forecast largely played out.

That 2022 scenario doesn’t apply today. Instead, what seems to be their reasoning is that inflation is largely a function of supply shocks – tariffs and energy prices. But arguably demand is running too hot as well. In a world with less trade and immigration, and in the middle of a resource-intensive AI boom, a 4.1% unemployment rate might be too low to keep inflation at 2%.

And then from here, housing seems more likely to contribute to higher rather than lower inflation over the next couple years. The entry-level market remains under pressure, and it’s fair to believe activity levels and prices there will remain soft into 2027. But the higher end of the market remains resilient, driven in part by stock market wealth. On the rental side, Zillow actually increased their forecast for rent growth in the fourth quarter of 2026, taking it up to 2.1% from 1.9% a month ago. The industry largely believes rent growth will pick up in 2027.

Even if you’re more cautious on the demand side than I am, the comments from the industry on the cost side are more concerning. The housing industry, policymakers, and the general public all think and hope we’re at the end of a construction downturn, and in the future we’ll be building more housing. Builders and suppliers need that to be the case because investors won’t accept current levels of profit margins. If cost pressures are emerging already, at the bottom of a downturn and when interest rates are elevated, what will conditions look like when demand returns and the industry is trying to grow housing production?

The most obvious conclusion is whatever upturn in residential construction we end up getting is going to be fairly inflationary. That’s bad news not just on the affordability front, but also for the Fed that needs all the help they can get when it comes to price levels. Rents and construction costs are likely to rise faster in 2027 than they did in 2026 – that’s typical for a cyclical industry at the end of a downturn. But it’s challenging for a Fed that needs inflation to come down and doesn’t have a compelling case for how they can make that happen in a painless way.