U.S. homebuilding has plummeted to its lowest point in over three years in August, primarily due to rising mortgage rates that have dampened housing demand. However, a surge in building permits indicates that new construction is still sustained by the scarcity of available homes in the market.

The decline in housing starts, reported by the Commerce Department, marked the most substantial drop in a year and affected various sectors. This follows the recent news that homebuilders' confidence hit a five-month low in September, with more builders resorting to price cuts and incentives to attract buyers.

Home construction, along with new home sales, has been a bright spot in the housing market, which has been heavily impacted by the Federal Reserve's aggressive tightening of monetary policy. The central bank is expected to keep interest rates steady on Wednesday after raising them by 525 basis points since March 2022 to the current range of 5.25%-5.50%.

While the data reveals a decline in home construction, experts note that much of the sharp decline in starts came from the volatile multifamily sector. Demand for new construction has been driven by a shortage of existing homes on the market, with builders increasing activity throughout the year. However, a recent surge in mortgage rates, along with higher U.S. Treasury yields, has prompted buyers to pause. The average rate for a 30-year fixed mortgage is now around 7.18%, the highest since March 2002.

Despite the challenges, there is optimism for a rebound in the housing market, with permits for future homebuilding rising to their highest level since October 2022. Multi-family housing permits, in particular, surged, while single-family housing permits also saw an increase. This undersupply of single-family homes on the market presents growth opportunities for home builders, especially those focusing on entry-level homes for millennials eager to buy.

While residential investment has contracted for nine consecutive quarters, experts anticipate some reversal of the decline in September. The housing backlog has also increased, indicating potential for future construction activity. However, the construction sector continues to face financial constraints and an oversupply of multi-family housing projects, limiting overall growth potential.