Existing-Home Sales Outperform Market Potential, According to First American Potential Home Sales Model
Rising tenure length means both fewer buyers and fewer homes on the market, and a reduction in the market potential for existing-home sales, says Chief Economist Mark Fleming
September 18, 2019, Santa Ana, Calif.
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 August 2019.
August 2019 Potential Home Sales
Potential existing-home sales increased to a 5.18 million seasonally adjusted annualized rate (SAAR), a 0.2 percent month-over-month increase.
This represents a 54.2 percent increase from the market potential low point reached in February 1993.
The market potential for existing-home sales declined by 1.9 percent compared with a year ago, a loss of 102,760 (SAAR) sales.
Currently, potential existing-home sales is 1.55 million (SAAR), or 23.1 percent below the pre-recession peak of market potential, which occurred in March 2004.
Market Performance Gap
- The market for existing-home sales is marginally overperforming its potential by 0.8 percent or an estimated 41,519 (SAAR) sales.
- The market performance gap increased by an estimated 23,000 (SAAR) sales between July 2019 and August 2019.
Chief Economist Analysis: Housing Market Exceeds Potential in August
“The housing market exceeded its potential in August 2019, as actual existing-home sales were 0.8 percent above the market’s potential. Housing market potential increased relative to last month, but declined 1.9 percent compared with August of last year,” said Mark Fleming, chief economist at First American. “While down compared with a year ago, existing-home sales have slightly outperformed market potential since February 2019, begging the question – how can existing-home sales exceed market potential?”
What is Market Potential, Anyway?
“Let’s first explain what ‘potential’ means in the scope of economics. Potential gross domestic product (GDP) is the level of production the economy is capable of if its workforce is fully employed and its capital stock is fully utilized,” said Fleming. “In other words, the total capacity of a nation to produce goods and services. The difference between actual GDP and potential GDP is known as the output gap, which indicates how much the economy is overperforming or underperforming its potential.
“The concept behind potential home sales is very similar. Our Potential Home Sales Model measures what a healthy level of home sales should be based on a variety of economic, demographic and housing market metrics,” said Fleming. “The performance (output) gap indicates how much actual existing-home sales are over or underperforming market potential.”
Why are Existing-Home Sales Outperforming Market Potential?
“In today’s real economy, real GDP is exceeding its potential, the unemployment rate is outperforming its potential or “natural” rate, and now existing-home sales are outperforming market potential,” said Fleming. “In other words, given the historical relationship between existing-home sales and population demographic data, homeowner tenure, house-buying power, house price trends and conditions in the financial market, the pace of existing-home sales is exceeding what we believe is fundamentally supported by the market. The main reason? Rising tenure length.
“While several forces are working to boost the market potential for existing-home sales, the low supply of homes for sale continues to hold market potential back. Existing-home sales make up approximately 90 percent of all home sales, which means existing homeowners must sell their homes in order for homes to be available for sale,” said Fleming. “Rising tenure length means both fewer buyers and fewer homes on the market, and a reduction in the market potential for existing-home sales. You can’t buy what’s not for sale, and you won’t buy, if you don’t sell.”
Too Soon to Tell
“While actual existing-home sales have outperformed market potential for the last six months, the performance gap has been very small,” said Fleming. “When the actual level of existing-home sales is significantly above the market potential for home sales, the likelihood of a market correction increases.
“Today, the performance gap is not at the level that implies a possible market correction. In fact, there are signs that the market potential for existing-homes may begin to rise,” said Fleming. “The year-over-year growth in tenure length has been slowing since March of this year and it is conceivable that it could stabilize or even decline. Tenure length is largely the result of the rate ‘lock-in’ effect, and seniors aging in place.
“In the latest Freddie Mac weekly report of mortgage rates, the 30-year, fixed mortgage rate was 3.5 percent, approaching the lowest mortgage rate in history of 3.3 percent, which occurred in 2012. If mortgage rates remain this low or even fall further, more existing-home owners may be enticed to move as the rate ‘lock-in’ effect fades,” said Fleming. “While actual existing-home sales are marginally outperforming market potential this month, declining mortgage rates could be the factor that bridges the gap.”
The next Potential Home Sales Model will be released on October 21, 2019 with September 2019 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.
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. © 2019 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; property and casualty insurance; banking, trust and wealth management services; and other related products and services. With total revenue of $5.7 billion in 2018, the company offers its products and services directly and through its agents throughout the United States and abroad. In 2019, First American was named to the Fortune 100 Best Companies to Work For® list for the fourth consecutive year. More information about the company can be found at www.firstam.com.