The final Potential Home Sales Model report of 2021 revealed that market potential ended the year on a strong note. While the winter months are traditionally real estate’s slow season, our measure of the market potential for existing-home sales showed the housing market again broke with traditional seasonal patterns by ending the year strong. In December 2021, housing market potential increased 5.0 percent compared with one year ago, but declined modestly on a month-over-month basis to a 6.37 million seasonally adjusted annualized rate (SAAR) of existing-home sales. The strength of the housing market is not surprising given the ongoing wave of millennial demand propelled by historically low rates and greater geographic flexibility due to work-from-home arrangements. Yet, home buyers face a historic and worsening housing supply shortage - you can’t buy what’s not for sale. 

“The strength of the housing market is not surprising given the ongoing wave of millennial demand propelled by historically low rates and greater geographic flexibility due to work-from-home arrangements.”

Millennials Super-Charge Housing Market Demand 

Potential home sales measures what the healthy market level of home sales should be based on economic, demographic and housing market fundamentals. One of the most consistent drivers of housing market potential over the last year has been new household formation. Millennials are the largest generation in U.S. history, and the bulk of them are aging into their prime home-buying years. New household formation, which is the new demand for housing, contributed approximately 165,000 potential home sales compared with one year ago. Even as house-buying power declined by nearly $3,000 on a year-over-year basis due to higher mortgage rates, housing demand persisted because the decision to buy a home is not strictly a financial decision, but also a lifestyle decision. The challenge for new millennial households is the lack of supply, particularly at the starter home price range. 
 

Housing Musical Chairs  

Homeowners in areas where house prices are rising feel wealthier. American homeowners today enjoy record levels of equity, and as their equity grows, they are more likely to consider using that equity to purchase a larger or more attractive home – the wealth effect of rising equity. In the existing-home sales report from the National Association of Realtors (NAR) for November 2021, the increase in home sales was strongest at the upper end of the market, as sales of homes priced at more than $1 million spiked over 50 percent nationally, followed closely by homes in the $750,000 to $1 million range, which jumped 37 percent. Existing homeowners are playing “housing musical chairs” by selling to each other. In December, the growing wealth effect of rising equity caused by house price appreciation increased housing market potential by 215,000 potential home sales relative to one year ago.  

You Can’t Buy What’s Not for Sale

The dominant force holding back more housing market potential in December relative to one year ago was the lack of housing supply. Housing supply in today’s housing market remains so tight and demand so strong that in the November 2021 NAR existing home sales report 83 percent of all homes listed for sale were sold within the month, with days on market at 18 days, down from 21 days in November 2020. The ongoing supply shortage continues to put upward pressure on house price appreciation as buyers compete to buy what few homes are for sale. You can’t buy what’s not for sale, but you will compete for what is.  
 

The shortage of homes for sale and the increase in house price appreciation is problematic for potential first-time home buyers, who tend to be younger and do not have the equity from the sale of an existing home to bring to the closing table. Existing homeowners can use the equity from the sale of their current home to purchase a bigger or better home, if they can find one they want. Rapid house price appreciation and its differing impact on existing and first-time home buyers will persist until the supply and demand imbalance improves. In the game of housing musical chairs, it’s clear the housing market needs more chairs.

Underlying data revisions contributed to an update to the Potential Home Sales Model from 2018-forward.

December 2021 Potential Home Sales 
For the month of December, First American updated its proprietary Potential Home Sales Model to show that: 

• Potential existing-home sales decreased to a 6.37 million seasonally adjusted annualized rate (SAAR), a 0.4 percent month-over-month decrease. 

• This represents an 82.8 percent increase from the market potential low point reached in February 1993. 
• The market potential for existing-home sales increased 5.0 percent compared with a year ago, a gain of 304,000 (SAAR) sales. 
• Currently, potential existing-home sales is 419,000 (SAAR), or 6.2 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 10.4 percent or an estimated 662,000 (SAAR) sales.  
• The market performance gap increased by an estimated 96,000 (SAAR) sales between November 2021 and December 2021. 
   

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-home 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.