The housing market started the year off strong, with the market potential for existing-home sales reaching its highest level since January 2018, according to our Potential Home Sales Model. Housing market potential increased 1.4 percent in January 2020 relative to the previous month, and grew 4.7 percent year over year, an increase of 240,050 potential existing-home sales and the highest rate of yearly growth since December 2017. Actual existing-home sales exceeded housing market potential by 1.0 percent, or an estimated 53,900 seasonally adjusted annualized sales.

“Build it and the homebodies just might buy it and provide welcome supply to the housing market.”

Demand Soars, Supply Sinks

The growth in market potential for existing-home sales was primarily fueled by positive market demand dynamics. In 2020, 4.8 million millennials will turn 30 – the peak age for home-buying. They’re fortunate to be entering the housing market at a time of historically low mortgage rates and a strong economy. However, there are challenges. Millennials face a very limited supply of existing homes available for sale, especially homes in the entry-level price range. In January, the positive impact from market demand outweighed the negative impact of limited supply, boosting housing market potential relative to one year ago.

Lower Rates and Wage Growth Boost Affordability:

The primary reason for increased housing market potential compared with one year ago was increased house-buying power, how much home one can afford to buy given household income and the prevailing mortgage rate. In January, after three months of slightly increasing mortgage rates, the 30-year, fixed-rate mortgage declined to 3.6 percent, 0.8 percentage points lower than one year ago. At the same time, the healthy labor market continued to boost wage growth, contributing to a 2.6 percent increase in household income. Low mortgage rates and income growth triggered a 13.5 percent increase in house-buying power compared with a year ago. This increase in house-buying power had the greatest impact on housing market potential in January, boosting market potential by 343,250 potential home sales.

New Household Growth Boosts Demand for Homes:

According to recent estimates, 1.65 million new households were formed between December 2018 and December 2019. As more new households are formed, demand for housing rises. The increase in household formation enhanced market potential by 103,380 potential home sales in January compared with last year.

End of Year Housing Supply Relief:

While the construction of new homes, specifically much needed single-family homes, remains below what is needed to satisfy demand, homebuilding took a sharp turn higher at the end of 2019. As new housing supply enters the market, the risk of not being able to find something to buy lessens, so homeowners may become more confident in the decision to sell their existing home. Compared with last year, the addition of new supply increased housing market potential by a modest 248 potential home sales.

Homebodies Holding Back Market Potential

The lack of existing homes available for sale is the most significant hindrance to housing market potential. Interestingly, the same dynamic that’s making homes more affordable is preventing more supply from entering the market. Persistently low mortgage rates can discourage existing homeowners from selling. The majority of homeowners already have a low mortgage rate because there has been ample opportunity to refinance to lower rates over the last decade. So, for a homeowner with a low mortgage rate, the only house-buying power advantage comes from household income growth. Many homeowners decide to “stay put,” as observed by rising average tenure length, and the inventory of homes for sale dwindles further.

The aging of the U.S. population has also contributed to rising tenure length as many aging silent generation, baby boomer and Generation X homeowners decide to remain in their existing homes. More than half of all existing homes are owned by baby boomers and the silent generation, and they are choosing not to sell and consequently not buy either.

While the year-over-year growth of tenure length slowed in January 2020, it is still 8.0 percent higher than one year ago. The increase in tenure length had the only negative impact on housing market potential this month, reducing it by 376,110 potential home sales compared with one year ago.

Should We Expect More Good News for Housing in 2020?

Housing demand is expected to grow in 2020, as millennials continue to form new households and mortgage rates remain below 4 percent. Additionally, wage growth driven by a strong labor market will continue to support house-buying power growth. While it’s unlikely that tenure length will decline significantly in a low and unchanging mortgage rate environment, additional new housing supply can incentivize existing homeowners to move. Build it and the homebodies just might buy it and provide welcome supply to the housing market.

January 2020 Potential Home Sales

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

• Potential existing-home sales increased to a 5.36 million seasonally adjusted annualized rate (SAAR), a 1.4 percent month-over-month increase.
• This represents a 59.7 percent increase from the market potential low point reached in February 1993.
• The market potential for existing-home sales increased by 4.7 percent compared with a year ago, a gain of 240,050 (SAAR) sales.
• Currently, potential existing-home sales is 1.37 million (SAAR), or 20.3 percent below the pre-recession peak of market potential, which occurred in March 2004.

Market Performance Gap

• The market for existing-home sales outperformed its potential by 1.0 percent or an estimated 53,900 (SAAR) sales.
• The market performance gap decreased by an estimated 14,400 (SAAR) sales between December 2019 and January 2020.
  
  

First American Deputy Chief Economist Odeta Kushi contributed to this post.

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, 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.