House Price Appreciation May Not Lift Market Potential, According to First American Potential Home Sales Model
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, says Chief Economist Mark Fleming
October 15, 2021, 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 September 2021. The Potential Home Sales Model measures what the healthy market level of home sales should be based on economic, demographic, and housing market fundamentals.
September 2021 Potential Home Sales
For the month of September, First American updated its proprietary Potential Home Sales Model to show that:
- Potential existing-home sales increased to a 6.24 million seasonally adjusted annualized rate (SAAR), a 0.4 percent month-over-month increase.
- This represents a 79.1 percent increase from the market potential low point reached in February 1993.
- The market potential for existing-home sales increased 8.7 percent compared with a year ago, a gain of 501,020 (SAAR) sales.
- Currently, potential existing-home sales is 545,800 (SAAR), or 8.0 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 8.1 percent or an estimated 506,050 (SAAR) sales.
- The market performance gap increased by an estimated 89,340 (SAAR) sales between August 2021 and September 2021.
Chief Economist Analysis: Housing Market Potential Up Modestly from August
“Housing market potential strengthened modestly in September, increasing a 0.4 percent compared with August, according to our Potential Home Sales Model,” said Mark Fleming, chief economist at First American. “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,” said Fleming. “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.”
Wealth Effect or Not? That Is the Question
“In today’s housing market, strong demand in combination with the historically low supply of homes for sale has fueled record house price appreciation. 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,” said Fleming. “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.
“Does it make sense that rising house prices can help spur more home sales? It depends. 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. 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,” said Fleming. “Since first-time home buyers 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,” said Fleming. “While inventory for new and existing homes has modestly increased in recent months, it remains near historic lows.
“Existing homeowners considering the possibility of listing their home for sale today must first contend with the prospect of finding something 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,” said Fleming. “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.”
If Not Equity, Then What?
“There is something else that may encourage an existing homeowner to move, and that is falling mortgage rates. When rates fall, an existing homeowner can buy the same amount of home for a lower monthly payment or buy more home for the same monthly payment, because the lower rates boost their house-buying power,” said Fleming. “However, rates are expected to rise in the coming months as the economy continues to improve.
“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?”
The next Potential Home Sales Model will be released on November 19, 2021 with October 2021 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. © 2021 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 $7.1 billion in 2020, 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.
 This release includes a revision to the annual income series using the 2020 Current Population Survey Annual Social and Economic Supplement (CPS ASEC)