Homebuying power has been in decline but the market fundamentals remain as strong as they were in 2019. Here is some advice from First American Chief Economist Mark Fleming.

The market forces that lit a match under the housing market during the early pandemic have deteriorated in recent months, but several key factors this year have kept sales from falling faster.

Rising mortgage rates played a role in the number of potential home sales that market conditions would support falling by 2.5 percent from May to June, and resting 13.1 percent below their levels from the same time the previous year, according to an analysis by First American Financial Corp. 

“Relative to last year, the reduction in demand stemming from falling house-buying power, tighter credit, and homeowners staying put resulted in a significant decline in the market potential for existing-home sales,” First American Chief Economist Mark Fleming said in the report. “Yet, despite these headwinds, market potential is currently near early 2019 levels.” 

To arrive at this estimate of “potential sales,” First American created a data model that considers how American homebuying power, demographic data and other housing-market fundamentals affect demand for homes. This model is used to predict the number of actual sales of existing homes in the National Association of Realtors’ monthly report.

By comparison, the number of actual home sales has been falling faster than these fundamentals alone would explain.

Sales of existing homes ticked down 5.4 percent between May and June — more than twice as fast as these market indicators suggested they might.

The chart below shows how closely demand for homes tends to track with these fundamentals. It also demonstrates how buyers tend to be more exuberant when fundamentals are improving, and more wary when broader conditions worsen.

While the reason for this split isn’t entirely clear, the model has identified some things that are actually bolstering the demand for homes, even as other factors tug it downward.

Here are the three that stood out most in First American’s model.

1. Equity-rich homeowners

Today’s record-high house prices can sideline some buyers, especially now that the era of ultra-cheap home loans appears to be over.

But those same prices can also be a draw for some sellers to enter the market and cash in on the ample equity they’ve built in their properties.

Most of these same sellers also immediately enter the buying pool — with some looking to leverage their equity to upgrade to a bigger or nicer home.

This aspect of home price appreciation has increased the housing market’s potential sales by 193,000 over the past year, the model suggests.

“This may be particularly important in an environment where house price growth is beginning to moderate,” Fleming said, “as sellers may be tempted to jump into the market to capture the higher sale price, yet these potential sellers must also contend with a rising interest rate environment.”

2. Demographic shifts

As the population grows, new households naturally form — and these families need somewhere to live.

Like the rise in homeowner equity, this factor can place upward pressure on the housing market.

“The more households formed, the higher the demand for homes,” Fleming said in the report.

This factor alone accounted for an increase of 43,000 potential home sales in June compared to the same month last year, the model estimates.

3. Builders playing catchup

Some homeowners may be reluctant to sell if they believe the pickings on the home market are too slim.

That’s where the flurry of new home construction that kicked off during the pandemic may start to ease those concerns for folks on the fence about listing their own homes.

“As homebuilders bring more new homes to the market, the risk of not being able to find something to buy lessens and homeowners’ confidence in the decision to sell their existing home grows,” Fleming said. “Compared with last year, more new-home supply is entering the market, increasing housing market potential by 1,400 potential home sales.”

That may not seem like a huge difference. But it’s likely a big improvement over what came before, when builders took a decade-and-a-half to return to somewhat normal construction levels after the housing crash of 2007.

But that recovery in home construction may once again be short-lived.

This data is from June, and accounts for some of the recent downturn in demand for newly constructed homes. But in the weeks since then, the economic climate has gotten more dire for builders — with demand falling fast and builder sentiment deteriorating quickly.

If those things continue on their current trajectory, this category could slip from a net positive to a drain on market demand once again.

“As the housing market adjusts to a post-pandemic norm with higher mortgage rates, housing market potential will subside from recent highs,” Fleming said, “but those highs were the exception and not the norm.”

Email Daniel Houston

This post was originally published on this site