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First American: House price appreciation may not lift market potential

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Market Data
Tuesday, October 26, 2021
Potential existing-home sales increased to a 6.24 million seasonally adjusted annualized rate (SAAR), a 0.4 percent month-over-month increase and 8.7 percent year-over-year increase, according to First American’s Potential Home Sales Model for September.

The September rate also marks 79 percent increase from the market potential low point in February 1993, according to First American.

The market for existing-home sales outperformed its potential by 8.1 percent, and the market performance gap increased by an estimated 89,340 (SAAR) sales between August and September.

“Housing market potential strengthened modestly in September, increasing a 0.4 percent compared with August, according to our Potential Home Sales Model,” First American Chief Economist Mark Fleming said in a release. “The slight increase means that on a year-over-year basis, housing market potential is now nearly 9 percent higher than in September 2020, when the housing market’s summer rebound was accelerating, following the initial pandemic-driven decline in the spring.

“Potential home sales measures what the healthy market level of home sales should be based on economic, demographic, and housing market fundamentals. Actual existing-home sales have oscillated up and down on a month-to-month basis, while housing market potential has been consistently rising all year largely as a result of increasing house price appreciation. Historically, house prices and home sales have demonstrated a strong positive relationship – when house prices rise, so do home sales. But this relationship is not so straightforward.”

Today’s market is seeing record house price appreciation, Fleming said, fueled by strong demand and historically low housing inventory.

“On a month-over-month basis, the 1.4 percent increase in inflation-adjusted house price growth boosted housing market potential by more than 28,000 potential home sales relative to August,”  Fleming said. “In fact, this was one of the few market fundamentals driving housing market potential higher. Declining house-buying power and other factors dragged market potential down in September.”

Will rising house prices spur more sales? It depends, he said.

“It is economically rational to expect that record levels of equity may prompt homeowners to use that equity to purchase larger and more attractive homes, a dynamic known as the wealth effect of rising equity,” Fleming said. “In August’s existing-home sales report, the increase in home sales relative to one year ago was strongest at the upper end of the market, as sales of homes priced between $750,000 and $1 million increased 40.3 percent, followed closely by homes over $1 million, which increased 40 percent nationally. Since first-time homebuyers generally don’t purchase at the higher end of the market, the home sales at these price points are typically occurring among existing homeowners, who are playing ‘housing musical chairs’ by selling to each other. But it’s not so simple.

“While an existing homeowner may have more purchasing power because the equity in their home has surged as prices appreciated, the price of the bigger and better home they are interested in has also increased. And even if the owner has the purchasing power, it’s hard to buy what’s not for sale. While inventory for new and existing homes has modestly increased in recent months, it remains near historic lows.”

That means existing homeowners who are considering listing their homes for sale must first find a home to buy.

“The fear of not finding something to buy in a housing market with historically low inventory is one reason the average length of time homeowners live in their home has reached a high of nearly 10.7 years,” Fleming said. “In September, homeowners staying put contributed to a loss of nearly 2,200 potential home sales. So, the ‘wealth effect’ may not always be enough to encourage existing owners to sell.”

Falling mortgage rates also encourage homeowners to move. But, rates are expected to rise, Fleming said, as the economy improves.

“While existing homeowners are sitting on record levels of equity, many of these owners have also secured historically low fixed mortgage rates. There is a financial ‘lock-in’ effect that increases as mortgage rates rise and as the size of a mortgage increases. Rising mortgage rates means it costs more to borrow the same amount that the homeowner owes on their existing mortgage,” said Fleming. “The more the prevailing market mortgage rate exceeds the homeowner’s existing mortgage rate, the larger the lock-in effect. Why move out if you must move ‘down’ or pay more to move up?

“So, if two-thirds of Americans are homeowners and many have record levels of equity, should we expect them all to tap their equity and sell? Don’t count on it, because you can’t buy what’s not for sale, even if you can afford it, and why move out if you must move ‘down’ or pay more to move up?”

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