In this episode of The REconomy Podcast™ from First American, Chief Economist Mark Fleming and Deputy Chief Economist Odeta Kushi unveil their new Existing-Home Sales Outlook Report and break down what to expect from the existing-home market ahead of the 2024 spring home-buying season. 

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Listen to the REconomy Podcast™ Episode 86:

“We believe the majority of homeowners will still be rate locked-in this year, which will hold back existing-home sales. However, it is possible for mortgage rates to reach 5.6% in 2025. In fact, I just checked a few industry forecasts and it seems the average consensus mortgage rate forecast for 2025 is about 5.7%.” – Odeta Kushi, deputy chief economist at First American

Transcript:

Mark Fleming - Hello

Odeta Kushi - Hello and welcome to episode 86 of The REconomy Podcast, where we discuss economic issues that impact real estate, housing and affordability. I'm Odeta Kushi, deputy chief economist at First American and here with me is Mark Fleming, chief economist at First American. Now, in today's episode, we're going to attempt to answer the question, what is the outlook for existing-home sales? 

Mark Fleming - Hi Odeta. Um, outlooks, you say? Seems suspiciously like a qualitative forecast instead of the real thing.

Odeta Kushi - Maybe. 

Mark Fleming - Ok, then maybe we should first ask the question, why are they called existing homes? We call new construction homes, new homes, and so by rigorous logic, then shouldn't existing homes be called used homes? You know, new car, used car. When you buy a used car, it's not an existing car sale.

Odeta Kushi - You're really asking the tough questions here. Mark, the petition to change existing home sales to used home sales begins here and now. Or maybe we just put a poll out on X. 

Mark Fleming - Well, that's not a bad idea. I suspect there was a bit of good marketing, shall we say spin, involved in coming up with existing-home sales? But let's get back to our main point. Why would we even care about used home sales? I couldn't resist. 

Odeta Kushi - Used home sales. Well, I'm gonna go back to the original term. Historically, existing-home sales have made up a big chunk of overall sales, nearly 90%. The rest is made up of new-home sales.

Mark Fleming - So almost entirely existing sales. What about home inventory? 

Odeta Kushi - Very similar story. Although there's been a little bit of a divergence since the beginning of the pandemic. From 1990 until February 2020, existing-home inventory made up 88% of total inventory. But in the latest data, it's actually closer to 70%.

Mark Fleming - And I think the reason for that decline in the share of existing and increase in the share of new is twofold. Existing-home inventory has been on the decline, sellers have been on strike recently. So, the share of new homes in the inventory would go up, even if the actual number were consistent or the same. But the actual number of new homes for sale has also increased. So a twofold effect in the inventory share for new homes. 

Odeta Kushi - That's right, existing homeowners have been staying put, while builders have been busy hammering away building new homes.

Mark Fleming - Indeed, and that reminds me, have we added, We Built this City, the 1985 classic by Starship, to the REconomy playlist yet? The '80s hair is amazing in the video.

Odeta Kushi - Amazing is one way to think about it. But I assume that one has to be on there. Also, way to sneak in that '80s reference.

Mark Fleming - Had to be done. It's a great song and somewhat related to our industry. So you know, there we go. Now back to our topic. Existing-home sales are pretty important because in housing, a buyer is usually a seller, and you can't buy what's not for sale.

Odeta Kushi - That's right. And we know that the average tenure length in the U.S. has reached historic highs of approximately 11 years. In February of this year, the average tenure length was over 4% higher compared to one year ago. Again, those existing homeowners are choosing to stay put because they don't want to give up that pandemic-low mortgage rate. 

Mark Fleming - The ever-important rate lock in effect and the fear of not being able to find something to buy. Of course, people will move for other reasons -- death, divorce, marriage, relocation, etc. And with it being the start of the spring home-buying season, which is when nearly 40% of all existing-home sales in a year occur. The warming weather in the end of the academic school year make for a more optimal time to move and fuel the seasonal increase in housing market activity.

Odeta Kushi - That's right. I mean, we are still seeing existing-home sales happen, just not very many. According to the January NAR number, there were 4 million existing-home sales. That's a seasonally adjusted annualized rate. Now that is below the pre-pandemic historical average of nearly 5 million home sales. 

Mark Fleming - Yes, but what about when we account for the size of the market?

Odeta Kushi - That's a really good point. Existing-home sales of 5 million means something different in 1990 versus 2000 versus today, because the size of the market has increased. So, when we look at existing-home sales as a percentage of total households, the pre-pandemic historical average going back to 1990 was 4.4% of homes sold in a year. In early 2024, it's been around 3%.

Mark Fleming - That's certainly quite low. And I think we've highlighted why existing-home sales are so important to the housing industry, and even discussed one reason why they've been muted in today's market. But I think it's about time we get to that outlook part of the discussion, don't you?

Odeta Kushi - I think so. And luckily, I have a report that should help us answer our question. 

Mark Fleming - Planned, not planned transition. What a coincidence.

Odeta Kushi - What a coincidence, indeed. Our new Existing-Home Sales Outlook Report nowcasts existing-home sales based on the historical relationship between sales, demographic trends, house-buying power and the prevailing financial and economic conditions. Now, we're recording this episode in mid-March, which means our analysis for February existing-home sales is out. That's on our Econ Center at firstam.com/economics. But, rather than focus on the actual numbers predicted for February, I want to focus on the various drivers of existing-home sales that we include in this model. So we'll just use our February report to sort of frame that discussion.

Mark Fleming - Well, we can certainly at least mention that our prediction for February was a very, very modest rise from January. Not such a feat since January was pretty darn low, but at least it got better and not worse. And that was driven by...

Odeta Kushi - Drumroll, please. 

Mark Fleming - Oh, specifically, the one from the intro to We Built this City.

Odeta Kushi - Now an eye roll, and I think all listeners need to maybe look up the music video and listen to the song at this point. 

Mark Fleming - Easily found on YouTube.

Odeta Kushi - Easily found. So there were four drivers of the very modest increase, increasing household formation and credit availability, as well as strong economic conditions, all boosted are nowcast for existing-home sales in February. But the biggest reason was a narrowing mortgage rate spread.

Mark Fleming - This sounds like some really good news because, obviously, we've been talking about the fact that the spread has been elevated for the last year to year and a half. A narrowing of the spread between the average 30-year, fixed mortgage rate and the effective rate of interest on mortgage debt outstanding has fueled an increase in the projected monthly change in existing-home sales. However, the majority of existing homeowners still remain rate locked-in because the effect hasn't really changed a lot yet. You can't buy what's not for sale. And, even with the narrower mortgage rate spread, existing homeowners still aren't selling. 

Odeta Kushi - Yeah, and you know, the other drivers we mentioned are also important. Most people take out a mortgage when they buy a home. So loosening credit conditions allow more people to buy. 

Mark Fleming - And I think household formation is the other one. You mentioned when individuals form new households, whether through young adults moving out of their parents homes, couples moving in together or individuals deciding to live on their own, they create demand for additional housing. This demand can be for either purchasing a home or renting properties, but either way, more shelter demand drives higher sales activity.

Odeta Kushi - And we also mentioned economic conditions, which is generally referring to the health of the economy. Typically, a strong economy is important when people are making the biggest financial decision of their life that is buying a home.

Mark Fleming - Sometimes people are pretty sensible. And it's definitely important. Were there any factors that contributed negatively to the outlook for existing-home sales? 

Odeta Kushi - Well, in February, mortgage rates actually picked up a bit, which means that there was a decline in house-buying power. Declining affordability, all else held equal, puts downward pressure on home sales. That also makes a lot of sense, very sensible. So that was just a one-month example of how we're thinking about the outlook for existing-home sales. It's also important to look at leading indicators, such as mortgage applications and pending home sales. 

Mark Fleming - Of those two, mortgage applications are weekly, so we have a more timely view of the market. And, so far in March, purchase mortgage applications have increased compared with February. So we're seeing an increase in activity, albeit modest, possibly a good indication for our March nowcast.

Odeta Kushi - So what do we think the rest of the year will bring for existing-home sales?

Mark Fleming - Well, as any good economist would say, that, of course, depends. And it depends on monetary policy, which depends on the economy, labor market, and inflation. 

Odeta Kushi - Please do elaborate.

Mark Fleming - It seems like we've been talking about those things a lot recently, I think. So as I'm sure everyone is aware, inflation has been a little more persistent so far this year than we had all hoped, and the labor market and economy continued to remain strong, which in this topsy-turvy world is not so good when it comes to inflation. Still too good for the Fed's liking. And that means the Fed is in no rush to cut interest rates.

Odeta Kushi - And the market is beginning to adjust their expectations accordingly. At the end of December 2023, the overwhelming majority of the market expected between six-to-seven rate cuts this year, twice as much as the Fed's own forecasts anticipated. This has changed meaningfully since then. Now the market is expecting rate cuts to start in June of this year. And that we will end the year with maybe three-to-four 25-basis point rate cuts. But what does all that mean for existing-home sales?

Mark Fleming - Well, it means that we likely won't see rate cuts resulting in mortgage rate declines in time for the spring home-buying season. Punxsutawney Phil didn't see his shadow so spring should come early, but the Fed still sees shadows of inflation. But we could see mortgage rates steadily decline in the second half of the year, which bodes well for the housing market. Lower mortgage rates boost house-buying power for potential buyers and reduce the lock-in effect for sellers.

Odeta Kushi - Now, speaking of the rate lock-in effect, we've brought it up a couple of times on this episode. You recently sent me a paper, a pretty new paper. It's from October of last year. It's titled, Mortgage Lock-in Mobility and Labor Reallocation. And the paper's findings are very interesting and have some implications that are important to the question we're trying to answer today. The paper basically explores how homeowner mobility changes as the difference between the market mortgage rate and their current respective mortgage rate increases. And I think one of the most relevant findings from the paper is that the relationship between the change in mortgage rates and the rate at which people move flattens at about 180 basis points. In other words, wider rate differences don't really impact the likelihood of moving.

Mark Fleming - It's kind of like, enough is enough. It's just big, I'm not doing it. Right? 

Odeta Kushi - Right. 

Mark Fleming - Well, what's the effective rate of interest on mortgage debt outstanding right now? In other words, sort of an an average rate for those with mortgages. 

Odeta Kushi - So, as of Q4 2023, it was 3.8%, according to the Bureau of Economic Analysis.

Mark Fleming - And that would mean, according to this research, we add that 1.8 percentage points to the 3.8. That means the lock-in effect will persist until mortgage rates drop to below somewhere around 5.6%. And we're not necessarily expecting rates to go that low this year.

Odeta Kushi - True, it's not impossible, but it's certainly not our base scenario. We believe the majority of homeowners will still be rate locked-in this year, which will hold back existing-home sales. However, it is possible for mortgage rates to reach 5.6% in 2025. In fact, I just checked a few industry forecasts and it seems the average consensus mortgage rate forecast for 2025 is about 5.7%. 

Mark Fleming - There we go. So we just have to be a little more patient. That's why we keep saying that 2024, for the existing-home sales market, will be not-to-pandemic hot, not-to-2023 cold, but not quite right yet. We will see activity pick up if mortgage rates decline in the second half of the year, but it may take until 2025 before we see real normalization.

Odeta Kushi - All right. I'm gonna say it. 

Mark Fleming - Oh, please don't. Not at the end. 

Odeta Kushi - I have to, I have to. This outlook is assuming we don't have a recession or a reacceleration in inflation or you know, another global pandemic. 

Mark Fleming - Alright, alright. We get it. Lots of things can go wrong. Ever the pessimist?

Odeta Kushi - I believe my official designation is a dismal scientist. 

Mark Fleming - Agreed.

Odeta Kushi - Great. Alright. Well, that's it for today. Thank you for joining us on this episode of The REconomy Podcast. If you have an economics-related question you'd like us to feature in the future, you can email us at economics@firstam.com. And, as always, if you can't wait for the next episode, you can follow us on X. It's @OdetaKushi for me and @MFlemingEcon for Mark. Until next time.

Thank you for listening, and we hope you enjoyed this episode of The REconomy Podcast from First American. We're pleased to offer you even more economic content at firstam.com/economics. This episode is copyright 2024 by First American Financial Corporation. All rights reserved.

This transcript has been edited for clarity.