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Economic Center Blog
December 19, 2017

Tightening Supply Squeezes Market Potential

Written by Mark Fleming

First American’s proprietary Potential Home Sales model examines November 2017 data and includes analysis from First American Chief Economist Mark Fleming on how the real estate market is performing versus its potential.

November 2017 Potential Home Sales

For the month of November, First American updated its proprietary Potential Home Sales model to show that:

  • Potential existing-home sales decreased to a 5.96 million seasonally adjusted, annualized rate (SAAR), a 2.0 percent month-over-month decrease.
  • This represents a 98.3 percent increase from the market potential low point reached in December 2008.
  • In November, the market potential for existing-home sales decreased by 1.5 percent compared with a year ago, a loss of 93,000 (SAAR) sales.
  • Currently, potential existing-home sales is 404,000 (SAAR), or 6.8 percent, below the pre-recession peak of market potential, which occurred in July 2005.

Market Performance Gap

  • The market for existing-home sales is underperforming its potential by 7.3 percent or an estimated 438,000 (SAAR) sales.
  • Market potential decreased by an estimated 124,000 (SAAR) sales between October 2017 and November 2017.

"The housing supply shortage hindering the market today is likely to remain in 2018."


Housing Supply Shortage to Remain in 2018

“Strong first-time homebuyer demand continues with the help of low mortgage rates. But, tight supply continues to be the biggest constraint on housing market growth. Existing homeowners are increasingly prisoners in their own homes, preventing additional existing-home supply from entering the market. Homebuilders are also struggling to add more new home inventory, so both sources of housing supply face challenges,” said Mark Fleming, chief economist at First American. “The housing supply shortage hindering the market today is likely to remain in 2018.”

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Chief Economist Analysis Highlights

  • The housing market’s potential for existing-home sales decreased moderately between October 2017 and November 2017. The decrease was driven by a reduction in the expectation for future supply, even as mortgage rates, which remained below 4 percent for the sixth consecutive month, fuel demand.
  • Both sources of future housing supply, new homebuilding and existing homes, are not meeting market demand. The pace of new homebuilding faces headwinds. At the same time, the fear of not being able to find a home to buy is preventing homeowners from putting their homes on the market, as more homeowners are increasingly prisoners in their own homes. The number of homes for sale has declined on a year-over-year basis for the past 39 consecutive months.
  • The housing market has been underperforming its potential since May, although the market performance gap improved this month relative to the 12-month peak in the market performance gap measured in October.
  • The supply of homes for sale nationally has fallen 7.5 percent from a year ago, and homes are selling 8.5 percent faster than a year ago, according to Realtor.com.
  • The lack of inventory relative to demand is driving the fast pace of price appreciation. While rates have remained low and kept consumer house-buying power strong, the strength of house-buying power is not enough to offset rising prices, so affordability has suffered.

 

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 is 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. Historical context is critically important. Our potential home sales model measures what we believe a healthy market level of home sales should be based on the economic, demographic, and housing market environments.

 

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, income and labor market conditions 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 in order 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.

Topics: Interest Rates, Housing