First American’s proprietary Potential Home Sales Model measures what the healthy market level of home sales should be based on economic, demographic, and housing market fundamentals.
For the month of November, the main takeaways were: potential existing home sales decreased to 6.26 million annualized rate (SAAR), representing a 79.5% increase from the market potential low in February 1993. However, the market potential for existing-home sales increased 7.2% year-over-year, a gain of 422,000 (SAAR) sales. Currently, potential existing-home sales is 533,000 (SAAR), 7.9% below the pre-recession peak of market potential, which occurred in April 2006.
“Demand for homes was strong prior to the pandemic,” said Mark Fleming chief economist at First American, “then housing demand accelerated amid the pandemic as buyers wanted more space, enjoyed more geographic flexibility in where they could live, and benefited from increased house-buying power driven by record-low mortgage rates. While many of these factors will remain consistent in 2022, mortgage rates are widely expected to rise, so how will that impact home sales?”
Fleming explains that existing-home sales don’t always slow down when mortgage rates rise and are often more influenced by why mortgage rates are rising. “Looking back over almost 30 years, there have been six significant rising-mortgage rate eras,” said Fleming. “Rising mortgage rates led to declining existing-home sales in two of the six rising-rate eras.”
Fleming refers to the 2005-2006 rate-rising era preceding the 2008 housing crisis where sales fell dramatically. At the time, rates were driven by the Federal Reserve’s efforts to tame above-target inflation. The Fed’s move worked as the existing home sales decreased by more than 12% in one year. Additionally, Fleming references the 1994 rising-rate era when The Fed increased the federal funds rate to prevent strong economic growth from feeding inflation.
Overall, Fleming demonstrates through these examples that existing home sales are resilient in a rising-rate environment. “For example,” he says, “mortgage rates spiked in the summer of 2013 when the Fed indicated it would taper its quantitative easing policy of buying Treasury bonds and mortgage-backed securities. But this ‘taper tantrum’ had no negative impact on existing-home sales.”
“Most recently, in 2017, it took almost a year of rising rates, before the pace of existing-home sales declined below the pace of sales seen before rates started to rise,” said Fleming. “Context matters and each rising-rate era is different. The housing market’s response to rising rates depends on the reason why rates are rising.”
Overall, the Potential Home Sales model indicates household formation, higher house-buying power, and looser credit conditions, which will drive housing market potential relative to last year. However, limited inventory will continue to dampen housing market potential, a dynamic that’s expected to persist into 2022, Fleming predicts.
Although rising mortgage rates will reduce affordability in 2022, Fleming reminds us that each rate-rising environment is different and influenced by a variety of economic trends. The rising rates we see today are driven by a recovering economy. “Rising mortgage rates don’t change the other key housing market fundamental – strong millennial home buyer demand,” Fleming added, “which will continue to underpin the 2022 housing market.”
