The Fed Warns Of Housing Rush To The Exit

Historically, as home prices rise, more sellers are enticed to put their homes on the market. This time, however, something is different. Prices have risen dramatically over the last 18 months, yethousing inventory has fallen. This isn’t how things are supposed to be.

The important question is why. The answer will largely tell us what’s next for the housing market.

Is something today fundamentally different? Is this some sort of new economic model? Or is this simply a temporary, explainable divergence?

We’ve long speculated that there are two main reasons why homeowners have chosen not to sell, despite the higher prices. The first is that they have benchmarks to meet. They are literally waiting until they have positive equity again the the ability to sell without being caught short. The second, and perhaps more insidious reason, is that they are all, collectively, trying to squeeze as much profit from their homes as possible. Everyone wants to wait until the last minute.

Both of these reasons can rationally explain why inventory has remained so low, despite more and more incentive for homeowners to sell. However, if these actually are the real reasons, then we could have a mad-rush to the exits as soon as people start to think that we’re at, or slightly passedthe top.

We’ve had “pent-up supply” going back to 2006: sellers who either couldn’t sell or chose not to sell have been essentially stuck until just recently. There have been seven-plus years of fewer-than-normal real estate sales. That’s a lot of people who would normally have moved, but didn’t because their homes had fallen in value. That’s a lot of homeowners who have rational, justifiable reasons to list their homes at the first sign of home prices weakening again.

Yesterday, The Fed weighed in, reaching the same conclusion that we did.

Why Are Housing Inventories Low?

Inventories of homes for sale have been slow to bounce back since the 2007–09 recession, despite steady house price appreciation since January 2012. One probable reason why many homeowners are not putting their homes on the market is that their properties may still be worth less than the value of their mortgages, which would leave them owing additional money after a sale. In other cases, homeowners may simply be hoping that house prices will continue to rise, allowing them to recover lost equity.

As the housing market heats up and prices rise once again, existing home sales remain stuck at relatively low levels. The National Association of Realtors reports that some 4.5 million homes were sold in June 2013 at a seasonally adjusted annualized rate, roughly the same as at the end of the 1990s. Why have sales been so sluggish? Potential homebuyers frequently say very few homes are available for sale. This Economic Letter examines the factors influencing the inventory of homes available for sale and considers why they currently appear unnaturally low.

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No matter what the condition of the economy might be, some base level of inventory for sale always exists in the housing market. Young homeowners may sell their homes in order to relocate for a job or because their family has gotten larger and they need more space. Older homeowners may sell because they no longer need so much space or they want to turn their housing investment into cash as they reach retirement. All these reasons for selling can be thought of as life-cycle motives not necessarily tied to the business cycle. Such noncyclical factors produce a general level of churning in the housing market. Nevertheless, inventories show a distinct cyclical pattern, rising in good times and falling in bad times. This could be due to the cyclical nature of credit conditions. The risk premiums charged by lenders and their willingness to accept loan applications tend to ease during good economic times, allowing more potential buyers to enter the market. At the same time though, the level of house prices is by far the most important cyclical variable that influences the inventory of homes for sale.

Figure 1 shows the inventory and price level of vacant homes for sale as reported by the Census Bureau. These data are not an exact measure of total homes for sale since many properties on the market are still occupied. However, this data series has a long history indicating the relationship between inflation-adjusted house prices and inventory for sale. As the figure shows, inventories generally move with prices. Formal statistical tests indicate that changes in house prices have a causal effect on inventories and the two series are tied together in a long-run relationship. This makes sense. All else equal, rising house prices should make homeowners more willing to sell and inventories should rise.

This adjustment of inventories to house price changes may not be instantaneous. Moreover, other economic forces may disrupt the long-run relationship between inventories and house prices. In Figure 1, such a divergence is evident in the most recent time period. House prices have been recovering broadly since 2012. But house inventories have been generally declining. Only in recent months have inventories of homes for sale begun to rise.

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Another possible explanation for the breakdown in the normal relationship between prices and inventories of homes for sale is that homeowners may be taking a longer-term view of the housing market. It is well documented that house price changes are persistent, meaning that price rises are likely to be followed by more rises, and price drops by more drops. Homeowners with flexibility on the timing of their home sales can potentially take advantage of this persistence. If they observe prices going up, they may want to wait and gamble that the increases will continue, allowing them to sell later at a higher price.

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It turns out that variables such as recent house price appreciation and changes in employment are the most robust predictors of recent changes in housing inventory. In other words, once we account for changes in house prices and employment in a county, other variables, such as changes in the for-rent inventory, the underwater share, or local price-rent ratios, do little to explain the inventory of houses for sale. Thus, current homeowners may be making a rational choice to postpone selling in the hope that prices will rise further. However, this behavior tends to be short run. In the longer run, the link between the level of house prices and for-sale inventories is strong. If prices continue to rise, inventories for sale should eventually rise too.

Conclusion

History shows a long-run relationship between house prices and the number of houses available for sale. Thus, current inventories of homes for sale are low given more than a year of house price appreciation. County-level data suggest that many homeowners are waiting for prices to rise further in their markets. Markets that have seen the strongest house price appreciation and job growth are the ones where for-sale inventories have declined the most.

In other words, social mood is yet again dominating economic theory… for the short-term anyway. As best The Fed can determine, homeowners en masse are simply holding out for the most money. And, then homeowners en masse decide that they had better sell, the inventory of homes for sale could rise dramatically. Which, would cause buyers to become more cautious.

We know how that movie ends.