As the housing market adjusts to a post-pandemic normal with higher mortgage rates, housing market potential will subside from recent highs, according to First American Chief Economist Mark Fleming. But those highs were the exception, not the norm.
According to First American’s potential home sales model for June, potential existing-home sales decreased to a 5.47 million seasonally adjusted annualized rate (SAAR) in June, “down 2.5 percent compared to last month, and 13.1 percent lower than one year ago, which is near the same level as in early 2019,” Fleming said in a release.
“While housing-market potential remains strong from a historical perspective, it is down from pandemic highs. To understand why, one must look at how the fundamentals that drive the potential for existing-home sales have changed since June of last year,” he said.
One of those fundamentals is house-buying power, which can be thought of as how much home one can afford considering their income and the 30-year fixed mortgage rate.
“Mortgage rates in June were 2.5 percentage points higher than they were a year ago. Holding household income constant at its June 2021 level, the increase in mortgage rates reduced house-buying power by $123,500,” Fleming said. “A 4.4 percent annual increase in household income helped to mitigate some of the impact of rising rates on affordability. Once accounting for the rise in household income, house-buying power fell by $108,000 since June 2021. The overall decline in house-buying power reduced housing market potential by 522,000 potential home sales.”
Another fundamental is credit standards.
“Credit standards tightened in recent months due to increasing economic uncertainty and monetary policy tightening. Compared with a year ago, credit tightening reduced housing market potential by 458,000 potential home sales,” Fleming said.
Some fundamentals are boosting housing market potential, like rising house prices.
“As a homeowner gains equity in their home, they are more likely to consider using the equity to purchase a larger or more attractive home. However, if equity is low, homeowners are likely to remain ‘equity locked-in’ to their home,” Fleming said. “Compared with one year ago, house price appreciation increased housing market potential by nearly 193,000 potential home sales.”
An increase in household formation also increases the demand for homes, he added. “The growth in household formation contributed to 43,000 potential home sales in June compared with one year ago,” Fleming said.
More housing inventory is also boosting housing potential.
“As homebuilders bring more new homes to the market, the risk of not being able to find something to buy lessens and homeowners’ confidence in the decision to sell their existing home grows,” Fleming said. “Compared with last year, more new-home supply is entering the market, increasing housing market potential by 1,400 potential home sales.”
“Relative to last year, the reduction in demand stemming from falling house-buying power, tighter credit, and homeowners staying put resulted in a significant decline in the market potential for existing-home sales. Yet, despite these headwinds, market potential is currently near early 2019 levels,” Fleming said. “Households are continually forming and increasing demand for shelter, existing homeowners have record levels of home equity, and the fear of not being able to find something to buy is easing.”