Housing Market Potential Narrows Performance Gap in April, According to First American Potential Home Sales Model

The keys to closing the performance gap lie in where mortgage rates go from here and how existing homeowners resolve the dilemma to sell or not to sell, says Chief Economist Mark FlemingTime

SANTA ANA, Calif. (May 20, 2019) – 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 April 2019.

April 2019 Potential Home Sales

• Potential existing-home sales increased marginally to a 5.17 million seasonally adjusted annualized rate (SAAR), a 0.1 percent month-over-month increase.
• This represents a 54.1 percent increase from the market potential low point reached in February 1993.
• The market potential for existing-home sales declined by 1.3 percent compared with a year ago, a loss of 68,600 (SAAR) sales.
• Currently, potential existing-home sales is 1.56 million (SAAR), or 23.2 percent below the pre-recession peak of market potential, which occurred in March 2004.

Market Performance Gap

• The market for existing-home sales is underperforming its potential by 1.3 percent or an estimated 68,000 (SAAR) sales.
• The market performance gap decreased by an estimated 37,000 (SAAR) sales between March 2019 and April 2019.

Chief Economist Analysis: Why Did Housing Market Potential Improve in April?

“The housing market continued to underperform its potential in April 2019, but the performance gap shrank compared with March. Actual existing-home sales remain 1.3 percent below the market’s potential, but the performance gap narrowed from 2.0 percent last month, according to our Potential Home Sales model,” said Mark Fleming, chief economist at First American. “That means the housing market has the potential to support 68,000 more home sales at a seasonally adjusted annualized rate (SAAR).

“Lower mortgage rates in April loosened the ‘rate lock-in effect’ that has created a financial disincentive that prevents many existing homeowners from selling their homes. However, it was not enough to reduce the average tenure length, the amount of time a typical homeowner lives in their home, which has increased dramatically in the last year,” said Fleming. “Since existing homeowners supply the majority of the homes for sale and increasing tenure length indicates homeowners remain hesitant to sell, the housing market faces an ongoing supply shortage – you can’t buy what’s not for sale.

“New home construction brought more homes to the market this month, but the new supply was not enough to meet demand,” said Fleming. “While supply remains tight, the market potential for home sales increased month over month due to improved affordability driven by lower mortgage rates and rising wages and favorable demographics, as millennial first-time home buyer demand continues to rise.”

Existing Homeowners Dilemma – To Sell or Not to Sell

“Before the housing market crash in 2007, the average length of time someone lived in their home was approximately five years. Tenure jumped to seven years during the aftermath of the crash between 2008 and 2016,” said Fleming. “The most recent data shows that the average length of time someone lives in their home reached 11 years in April 2019, a 9 percent increase compared with a year ago. Increased tenure length reduced the market potential by 33,000 sales compared with last month.

“In 2018, rising mortgage rates, tight supply, low rates of foreclosure, and tight credit all contributed to the ongoing surge in homeowner tenure. The majority of existing homeowners have mortgages with historically low rates, so there is limited incentive to sell if it will cost them more each month to borrow the same amount of money from the bank,” said Fleming. “The dilemma facing existing homeowners today is how high must the cost of losing that low rate mortgage be to choose not to sell.”

House-Buying Power Wins Tug-of-War

“While increasing tenure length reduced market potential in April compared with the previous month, rising house-buying power offset the impact of tenure length on market potential. In April, mortgage rates reached their lowest point since January 2018 and the strong labor market persisted,” said Fleming. “Average hourly earnings continued their upward trend, growing at an annual rate of 3.4 percent, which resulted in a 2.6 percent year-over-year increase in average household income. With more income and lower mortgage rates, comes greater house-buying power. The increase in house-buying power increased market potential by 50,000 sales, compared with the previous month, by far the strongest driver of market potential in our model.

“Consumers reacted to the increase in house-buying power, as purchase applications in April reached their highest level in nine years. If mortgage rates continue their downward trend, the rate-lock in effect will diminish and more existing homeowners may be enticed to sell, bringing more supply to the market. In addition to stimulating supply by encouraging existing homeowners to sell their homes, declining mortgage rates will further increase demand by boosting house-buying power,” said Fleming. “In April, lower mortgage rates helped close the performance gap between the market’s potential and actual existing-home sales. The keys to closing the performance gap lie in where mortgage rates go from here and how existing homeowners resolve the dilemma to sell or not to sell.

What Insight Does the Potential Home Sales Model Reveal?

“When considering the right time to buy or sell a home, an important factor in the decision should be the market’s overall health, which is largely a function of supply and demand. Knowing how close the market is to a healthy level of activity can help consumers determine if it is a good time to buy or sell, and what might happen to the market in the future. That’s difficult to assess when looking at the number of homes sold at a particular point in time without understanding the health of the market at that time,” said Fleming. “Historical context is critically important. Our Potential Home Sales Model measures what home sales should be based on the economic, demographic and housing market environments.”

Next Release

The next Potential Home Sales Model will be released on June 20, 2019 with May 2019 data.

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.

Disclaimer

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.

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.