Written by First American Chief Economist, Mark Fleming
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.