First American credits two market dynamics for the underperformance. |

Housing Market Continues to Underperform its Potential

Carrie Rossenfeld Residential & Mixed Use

Santa Ana, California-based First American Financial Corporation has released its proprietary Potential Home Sales Model for the month of March 2018, which reveals that the housing market continued to underperform its potential, according to Mark Fleming, chief economist at First American. The market for existing-home sales is underperforming its potential by 4.5 percent or an estimated 273,000 seasonally adjusted annualized rate (SAAR) sales.

The report also reveals that potential existing-home sales increased to a 6.04 million (SAAR), a 0.3 percent month-over-month increase. This represents a 61.8 percent increase from the market potential low point reached in February 2011. The market potential for existing-home sales increased by 3.4 percent compared with a year ago, a gain of 201,190 (SAAR) sales.

Currently, potential existing-home sales is 1.25 million (SAAR), or 17.1 percent below the pre-recession peak of market potential, which occurred in July 2005. Also, the market performance gap increased by an estimated 22,700 (SAAR) sales between February 2018 and March 2018.

“The lack of supply is the primary culprit,” Fleming says. “The inventory of homes for sale in most markets remains historically tight, yet demand continues to rise as Millennials further age into homeownership. Limited supply and rising demand means house prices are surging, so why aren’t more existing homeowners selling their homes?”

Fleming says two market dynamics are at play. First, many existing homeowners are “rate-locked,” with the majority of existing homeowners’ mortgages having historically low rates and, now that rates are rising, they are hesitant to sell their homes. “They recognize that once they sell and purchase a new home, they will have a higher mortgage rate. There is limited incentive to sell when, due to higher mortgage rates, it will cost you more each month just to borrow the same amount from the bank. As mortgage rates rise further, more existing homeowners may become rate locked into their existing homes.”

Second, he says, the root of the second dynamic at play is that the housing market is not like most markets. “Typically, the seller, or supplier, makes their decision about adding supply to the market independent of the buyer, or source of demand, and their decision to buy. Yet, in the housing market, the seller and the buyer are, in many cases, actually the same person – the existing homeowner. In order to buy a new home, you have to sell the home you already own, and then find a home you like better. Every home is different, an almost perfectly heterogeneous product so, when supply is constrained like it is in today’s market, it becomes difficult to find a home better than what you already own.”

Fleming adds that potential sellers face a prisoner’s dilemma, a situation in which individuals don’t cooperate with each other, even though it seems in their best interest to do so. “If sellers all choose to sell, they would all benefit as buyers because they would increase the inventory of homes available and alleviate the supply shortage. However, the risk of selling if others don’t in a market with a shortage of inventory prevents many existing homeowners from selling. The result is prices are further bid up by competition for the increasingly short supply.