Rising Rates Unlikely to Dampen Spring Home-Buying Season, According to First American Potential Home Sales Model
Even if mortgage rates continue to rise, increasing household formation, in conjunction with more favorable market conditions, will keep home-buying demand high, says Chief Economist Mark Fleming
March 19, 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 February 2021.
February 2021 Potential Home Sales
- Potential existing-home sales increased to a 6.26 million seasonally adjusted annualized rate (SAAR), a 1.3 percent month-over-month increase.
- This represents a 79.6 percent increase from the market potential low point reached in February 1993.
- The market potential for existing-home sales increased 12.2 percent compared with a year ago, a gain of 682,900 (SAAR) sales.
- Currently, potential existing-home sales is 530,350 million (SAAR), or 7.8 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 3.9 percent or an estimated 243,600 (SAAR) sales.
- The market performance gap increased by an estimated 99,000 (SAAR) sales between January 2021 and February 2021.
Chief Economist Analysis: Housing Market Potential Soars to Highest Level Since 2007
“In February 2021, housing market potential increased to its highest level since 2007, despite the largest month-over-month jump in mortgage rates since October 2019. Housing market potential rose 1.3 percent in February relative to the previous month, and 12.2 percent year-over-year,” said Mark Fleming, chief economist at First American. “While rising average tenure length was the largest drag on housing market potential this month, the lift from still rising house-buying power, looser credit standards, and strong household formation outpaced the negative impact from limited supply, both new and existing. As we enter the spring-home buying season, these dynamics are poised to support continued strength in the housing market.”
The Good: Millennials Reach Peak Home-Buying Age Armed with Record House-Buying Power
- Demographics: “While mortgage rates increased by a modest 0.08 percentage points in February, house-buying power was modestly higher this month thanks to a rise in median household income. Yet, larger gains in market potential came from household formation. The month-over-month growth in household formation contributed to nearly 13,000 potential home sales,” said Fleming. “Buying a home is not just a financial choice, but also a lifestyle choice. Millennials are reaching their peak home-buying years in large numbers and have likely been considering buying a home for some time. A slight increase in rates may cause some millennials to adjust their price point, but it will not necessarily deter them from home buying.”
The Bad: You Can’t Buy What’s Not for Sale
- Rate Lock-In: “Most existing homeowners have mortgages with historically low rates, and there is limited incentive to sell if it will cost them more each month to borrow the same amount of money,” said Fleming. “While rates are only marginally higher today than the rock-bottom rates of 2.68 percent in December of last year, this increase can still leave existing homeowners feeling ‘rate locked-in’, disincentivizing them from selling their homes and preventing more supply from reaching the market.”
- The Existing Owner’s Dilemma: “The other supply constraint is rooted in the uniqueness of the housing market. In most markets, the seller makes the decision to add supply to the market independent of the buyer. Yet, in the housing market, the seller and the buyer are, in many cases, the same person – the existing homeowner. To buy a new home, you must also sell the home you already own, and then find a home you like better,” said Fleming. “Every home is different, an almost perfectly heterogeneous product, so when supply is constrained as in today’s market, it becomes difficult to find a home better than what you already own. The existing owner faces the dilemma of whether to sell or not when they fear not being able to find something to buy.”
- Lack of New Construction: “One way to solve the supply issue is by building new homes, but construction headwinds have limited the homebuilders’ ability to build enough homes to keep up with housing demand,” said Fleming.
The Maybe: The Positive Impacts from Growing Equity and Credit Loosening
- Home Equity: “Existing homeowners today are sitting on record amounts of equity. As homeowners gain equity in their homes, the temptation grows to list their current home for sale and use the equity to purchase a larger or more attractive home, if they can find one for sale,” said Fleming. “House price appreciation in January contributed to approximately 34,000 potential home sales in February, but remains uncertain in the days ahead. While homeowners may want to use their equity to buy something bigger and better, they first must find something to buy.”
- Credit: “The other ‘maybe’ is credit because the future of credit is critically dependent on the health of the economy. At the onset of the pandemic, tighter credit was the biggest contributor to the loss of potential home sales, as lenders tightened their credit criteria to account for a higher likelihood of forbearance and delinquency,” said Fleming. “In February, credit standards loosened due to positive economic news, and had the greatest positive impact on housing market potential on a month-over-month basis, contributing 41,000 potential home sales. The economic recovery is on track to strengthen, but some uncertainty remains.”
But the Likeliest Scenario Is…
“All factors considered, the market potential for existing-home sales remains well positioned to continue to rise. The economy will likely continue to improve with vaccine rollouts accelerating. With greater vaccination rates will come increased consumer and lender confidence, and a stronger labor market,” said Fleming. “Even if mortgage rates continue to rise, increasing household formation, in conjunction with more favorable market conditions, will keep home-buying demand high. In addition, the recent increase in housing starts means home builders are pushing through on new construction projects, which will work to alleviate some of the supply shortage in the longer run. But now? Expect continued strong demand and short supply, which means the spring home-buying season will be moving with a sales velocity that has not been seen before.”
The next Potential Home Sales Model will be released on April 20, 2021 with March 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 2020, First American was named to the Fortune 100 Best Companies to Work For® list for the fifth consecutive year. More information about the company can be found at www.firstam.com.