For January, First American Financial Corp. updated its 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. That’s an 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 in April 2006.
The market for existing-home sales outperformed its potential by 11.9 percent or an estimated 748,000 (SAAR) sales, and the market performance gap increased by an estimated 124,000 (SAAR) sales between December 2021 and January 2022.
“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,” First American Chief Economist Mark Fleming said in a release. “Demand for homes will remain strong in 2022, but declining affordability and lack of supply may limit market potential. Potential homebuyers 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.”
In January, the 30-year, fixed mortgage rate experienced a 35-basis point increase, the largest one-month jump since December 2016. That increase contributed to a $19,000 decline in house-buying power, Fleming said, reducing 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,” he said. “First-time homebuyers 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.”
Many first-time homebuyers had access to affordable housing through “filtering” where new homes filter down to a lower price tier through age and depreciation. With homeowners staying put longer, Fleming said, few homes are filtering down to potential first-time buyers.
“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,” he said. “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.”
There is some good news linked to rising mortgage rates, Fleming said: possible 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,” he said. “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.
“Housing market potential this year will depend on the degree to which potential first-time homebuyers 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.”