Housing Market Potential Hinges on Opposing Supply-Demand Forces, According to First American Potential Home Sales Model

—Housing market potential this year will depend on the degree to which potential first-time home buyers respond to changes in their house-buying power and homeowners’ decisions to list their homes for sale, says Chief Economist Mark Fleming—

First American Financial Corporation (NYSE: FAF), a leading global provider of title insurance, settlement services and risk solutions for real estate transactions, today released First American’s proprietary Potential Home Sales Model for the month of January 2022. The Potential Home Sales Model measures what the healthy market level of home sales should be based on economic, demographic, and housing market fundamentals.

January 2022 Potential Home Sales

For the month of January, First American updated its proprietary Potential Home Sales Model to show that:

• Potential existing-home sales decreased to a 6.31 million seasonally adjusted annualized rate (SAAR), a 0.9 percent month-over-month decrease.
• This represents a 80.9 percent increase from the market potential low point reached in February 1993.
• The market potential for existing-home sales increased 3.9 percent compared with a year ago, a gain of 238,000 (SAAR) sales.
• Currently, potential existing-home sales is 485,000 (SAAR), or 7.1 percent below the pre-recession peak of market potential, which occurred in April 2006.

Market Performance Gap

• The market for existing-home sales outperformed its potential by 11.9 percent or an estimated 748,000 (SAAR) sales.
• The market performance gap increased by an estimated 124,000 (SAAR) sales between December 2021 and January 2022.

Chief Economist Analysis: Market Potential for Existing-Home Sales Up 4 Percent Year Over Year

“While still 4 percent higher than one year ago, the market potential for existing-home sales declined to its lowest level since June 2021, according to the first Potential Home Sales Model report of 2022. Demand for homes will remain strong in 2022, but declining affordability and lack of supply may limit market potential,” said Mark Fleming, chief economist at First American. “Potential home buyers have little inventory to select from, and you can’t buy what’s not for sale. A rebalancing of the supply-demand dynamic is likely as demand moderates due to declining affordability, and house price appreciation slows down in response.”

Rebalancing Forces in the Housing Market

• Rising Rates Reduce Affordability: “In January, the 30-year, fixed mortgage rate experienced its largest one-month jump since December 2016. The 35-basis point increase in mortgage rates contributed to a $19,000 decline in house-buying power, which reduced housing market potential by 90,000 potential home sales. Mortgage rates have continued to drift upward in February and are expected to rise further in 2022. While the decision to purchase a home is not strictly financial, higher rates reduce house-buying power (all else held equal) and may force some potential buyers to lower their price point or to pull back from the market entirely,” said Fleming. “First-time home buyers will feel the squeeze of rising rates the most as the competition in one of the most competitive housing markets in history is even more pronounced in the lower-priced starter-home segment of the market. Yet, the affordability induced reduction in demand will reduce pressure on prices, given the ongoing supply constraints.”

• You Can’t Buy What’s Not for Sale: “Potential first-time home buyers have traditionally had access to affordable housing through filtering – a process by which a new home ‘filters’ down to lower relative price tiers as it ages and depreciates in quality. Yet, homeowners today are staying in their homes longer than ever – on average over 10 years – which means fewer homes are filtering down to potential first-time home buyers. Homeowners staying put reduced housing market potential by 7,000 home sales in January,” said Fleming. “There is limited incentive to sell when, due to higher mortgage rates, it will cost more each month to borrow the same amount as your existing mortgage from a lender, a phenomenon known as the ‘rate lock-in effect.’ The shortage of supply across the price spectrum also impacts existing homeowners looking to move up. To buy a new home, the existing owner first must sell their current home. When supply is constrained like it is in today’s market, it becomes more difficult to find a suitable upgrade.”

Housing Market Potential Hinges on Opposing Supply-Demand Forces

“Rising rates may negatively impact both housing affordability and supply, but it may also result in a housing market rebalancing. Double-digit nominal house price growth in combination with rising rates is likely to cause some buyers to pull back from the market, resulting in fewer and less intense bidding wars and, ultimately, a moderation in house price growth. Another important consideration is that builders have been busy breaking ground on more homes, which will help to alleviate some of the supply shortage this year. Household income is also on the rise, as average annual hourly wage growth remains near a 15-year high, which offsets some of the affordability loss from rising mortgage rates,” said Fleming. “Housing market potential this year will depend on the degree to which potential first-time home buyers respond to changes in their house-buying power and homeowners’ decisions to list their homes for sale. One possible outcome? A market that is closer to equilibrium, with less price appreciation than last year.”

Next Release

The next Potential Home Sales Model will be released on March 17, 2022 with February 2022 data.

About the Potential Home Sales Model

Potential home sales measures existing-homes sales, which include single-family homes, townhomes, condominiums and co-ops on a seasonally adjusted annualized rate based on the historical relationship between existing-home sales and U.S. population demographic data, homeowner tenure, house-buying power in the U.S. economy, price trends in the U.S. housing market, and conditions in the financial market. When the actual level of existing-home sales are significantly above potential home sales, the pace of turnover is not supported by market fundamentals and there is an increased likelihood of a market correction. Conversely, seasonally adjusted, annualized rates of actual existing-home sales below the level of potential existing-home sales indicate market turnover is underperforming the rate fundamentally supported by the current conditions. Actual seasonally adjusted annualized existing-home sales may exceed or fall short of the potential rate of sales for a variety of reasons, including non-traditional market conditions, policy constraints and market participant behavior. Recent potential home sale estimates are subject to revision to reflect the most up-to-date information available on the economy, housing market and financial conditions. The Potential Home Sales model is published prior to the National Association of Realtors’ Existing-Home Sales report each month.

Disclaimer

Opinions, estimates, forecasts and other views contained in this page are those of First American’s Chief Economist, do not necessarily represent the views of First American or its management, should not be construed as indicating First American’s business prospects or expected results, and are subject to change without notice. Although the First American Economics team attempts to provide reliable, useful information, it does not guarantee that the information is accurate, current or suitable for any particular purpose. © 2022 by First American. Information from this page may be used with proper attribution.

About First American

First American Financial Corporation (NYSE: FAF) is a leading provider of title insurance, settlement services and risk solutions for real estate transactions that traces its heritage back to 1889. First American also provides title plant management services; title and other real property records and images; valuation products and services; home warranty products; banking, trust and wealth management services; and other related products and services. With total revenue of $9.2 billion in 2021, the company offers its products and services directly and through its agents throughout the United States and abroad. In 2021, First American was named to the Fortune 100 Best Companies to Work For^® list for the sixth consecutive year. More information about the company can be found at www.firstam.com. 

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