First American Financial Corporation has released its April 2023 Potential Home Sales Model which found two competing dynamics behind the housing market’s slow start the spring home-buying season. The Potential Home Sales Model measures what the healthy market level of home sales should be based on economic, demographic, and housing market fundamentals.
Based on April’s data, potential existing-home sales increased to a 5.34 million seasonally adjusted annual rate (SAAR), a 0.45% month-over-month increase. This represents a 53.3% increase from the market potential low point over 30 years ago in February 1993.
According to First American, the market potential for existing-home sales decreased 7.7% compared to a year ago, net loss of 443,350 (SAAR) sales. As of the end of April, potential existing home sales stand at 1,446,360 (SAAR) sales, or 21.3% below the pre-recession peak of market potential, which occurred in April 2006.
But according to Chief Economist Mark Fleming, housing potential increased modestly in April, but sellers and buyers are sitting on the sidelines due to the “lock-in effect.”
“The housing market remains sluggish heading into the spring home-buying season. While mortgage rates have retreated from recent peaks, they remain elevated compared with one year ago,” Fleming said. “Higher mortgage rates have a dual impact on sales—pricing out buyers who lose purchasing power and keeping some potential sellers rate-locked in. There are plenty of potential buyers sitting on the sidelines, but they are likely waiting for housing supply and affordability to improve before entering the market.”
“Our Potential Home Sales Model, which measures what we believe a healthy market for home sales should be, based on the economic, demographic and housing market environments, increased modestly in April, but the primary factor holding back housing market potential was existing homeowners staying put.”
According to Fleming, there are two reasons why homeowners are stay put which are:
The Golden Handcuffs of Low Mortgage Rates: “Existing homeowners are hesitant to sell their homes because mortgage rates are above 6%, and 83% of existing homeowners have mortgages with rates below 5%,” said Fleming. “Why would anyone sell their home when it will cost significantly more each month to borrow the same amount from the bank?”
When Your Castle Becomes Your Prison: “The housing market is unlike most markets. Typically, the seller, or supplier, makes their decision to add supply to the market independent of the buyer, or source of demand, and their decision to buy. Yet, in the housing market, the seller and the buyer are in many cases the same—the existing homeowner,” said Fleming. “To buy a new home, you must sell the home you already own, and then find a home to buy. But not just any home—one that you like better. Every home is different—an almost perfectly heterogeneous good. The fewer homes there are for sale, the harder it becomes to find something better than what you already have.
“Sellers face a prisoner’s dilemma, a situation in which individuals don’t cooperate with each other, even though it seems in their best interest to do so. If potential sellers all choose to sell, they would all benefit as buyers because they would increase the inventory of homes available and alleviate the supply shortage,” Fleming continued. “However, the risk of selling if others don’t in a market with a shortage of inventory prevents many existing homeowners from selling altogether.”
But as with everything, purchasing a home is more than just a financial decision.
“Of course, the decision to buy and sell is more than just a financial calculation. An existing homeowner may choose to sell for lifestyle reasons, even if it means losing their low mortgage rate. Additionally, 42% of homeowners own their home free-and-clear, so they are not deterred by higher mortgage rates,” Fleming concluded. “Even with these mitigating factors, it will be difficult for existing-home sales to meaningfully increase while homeowners remain chained to their homes by their golden handcuffs and confounded by the prisoner’s dilemma of whether to sell or not.”