THREE SCENARIOS for the 2026 HOUSING INVENTORY ABSORPTION

US housing inventory has been rising for 18 consecutive months as of March 2026, reversing the extreme supply constraint that characterised the 2021 to 2023 period. The months-supply figure for existing homes reached 4.2 months in February 2026, up from 2.6 months a year earlier. New home inventory reached 8.1 months supply, its highest level since 2010.

The rise in inventory is not uniform across geographies or price tiers. The Sun Belt markets that saw the most aggressive price appreciation in 2020 to 2022 (Phoenix, Austin, Tampa, Nashville) are showing inventory builds well above the national average. Coastal markets with more severe structural supply constraints (San Francisco, New York, Boston) have seen more modest inventory increases.

The critical dynamic is the rate-lock effect. Approximately 70 percent of outstanding US mortgages carry rates below 4.0 percent, established during the 2020 to 2022 period of near-zero short rates and QE-suppressed mortgage rates. Those homeowners face a punishing affordability penalty if they sell and re-enter the market at current mortgage rates of 6.5 to 7.0 percent. The result is a bifurcated market: rising inventory of new homes and distressed/forced-sale properties, but continued constraint on voluntary existing home supply.

US housing affordability, measured as the mortgage payment on a median-priced home at current rates as a percentage of median household income, stood at approximately 34 percent in early 2026. The historical average is approximately 24 to 26 percent. At 34 percent, the median US household is spending above the conventional 28 percent mortgage-to-income underwriting threshold, which constrains the eligible buyer pool.

The affordability problem is partially mechanical: it resolves either through price declines, rate declines or income growth. The desk's base case assumes income growth of 3.5 to 4.0 percent annually and mortgage rate decline to 6.0 to 6.3 percent by end-2026 as the FOMC easing cycle proceeds. At those parameters, affordability improves to approximately 30 to 31 percent, still above the historical norm but closer to the range where voluntary transaction volume recovers.

The geographic dispersion of affordability stress matters for investment positioning. Markets where the affordability problem is most acute (coastal California, parts of the Northeast, high-appreciation Sun Belt metros) face the most challenging demand environment. Markets where income growth is strong relative to home prices (Houston, Raleigh, Columbus, Indianapolis) have more resilient demand.

[SCENARIO A: ORDERLY ABSORPTION - 52%] Mortgage rates decline to 6.0 to 6.3 percent by Q4 2026. New home builders aggressively cut prices on standing inventory, clearing supply at 10 to 12 percent discounts to peak listing prices. Existing home sales recover modestly to 4.2 to 4.5 million units annualised. House prices nationally flat to down 3 to 5 percent by year-end. Credit quality stable. No systemic risk.

[SCENARIO B: REGIONAL STRESS - 32%] Rate decline fails to materialise on timeline (held at 6.8 to 7.0 percent through Q3 2026). Sun Belt markets see 8 to 12 percent price corrections in overbuilt segments. New home builder cancellation rates rise to 35 to 40 percent, forcing price cuts and operational stress for mid-tier builders. One or two regional builders face liquidity pressure. No systemic credit event but visible localised stress.

[SCENARIO C: CREDIT EVENT - 16%] Mortgage rate spike to 7.5 percent or above driven by fiscal or inflation shock. Affordability collapses further. Demand withdrawal accelerates inventory build. Commercial real estate stress spills over into residential via regional bank credit tightening. Price declines of 12 to 18 percent in most stressed markets. One or two regional banks face elevated credit losses on residential construction loans.

The public homebuilders (D.R. Horton, Lennar, PulteGroup, NVR, Taylor Morrison) entered 2026 with significantly different balance sheet and order book positions than in the 2006 to 2008 cycle that nearly destroyed the sector.

Key differences: debt-to-equity ratios are materially lower, with most public builders at 20 to 40 percent net debt-to-capital versus 80 to 120 percent in 2006; land ownership is less speculative, with more optioned than owned land; cancellation rates of 20 to 25 percent are elevated but manageable given current margins.

D.R. Horton's entry-level focused model with tight cost discipline is best positioned in the base case. NVR's asset-light, option-heavy land model provides the most downside protection in Scenario B. Mid-tier builders with high Sun Belt exposure are most vulnerable.

The desk maintains a modest long on the sector with a preference for D.R. Horton and NVR. Reduce on further mortgage rate increases or evidence that cancellation rates are accelerating beyond 28 to 30 percent.

Residential REITs (single-family rental) offer an interesting asymmetric exposure to the housing stress scenario. When home purchase affordability is impaired, rental demand typically strengthens. The large SFR REITs (Invitation Homes, AMH) benefit from the same affordability constraint that hurts transaction volumes.

Mortgage REITs face a more complex environment. Agency MBS spreads have been relatively stable but are vulnerable to supply increases if Fannie/Freddie reform advances, and to duration risk if the rate path proves more volatile than currently priced.

For direct housing exposure: the desk prefers selective Sun Belt homebuilders with strong balance sheets and entry-level focus over luxury or second-home market exposure, which faces deeper demand destruction in the stress scenarios.