Market Overview

Two Market Dynamics Fueling the Housing Shortage, According to First American Potential Home Sales Model


—There are two reasons why existing homeowners have become
prisoners in their own castles – the rate lock-in effect and the
seller's prisoner's dilemma, says Chief Economist Mark Fleming—

American Financial Corporation
leading global provider of title insurance, settlement services and risk
solutions for real estate transactions, today released First American's
proprietary Potential
Home Sales Model
for the month of March 2018.

March 2018 Potential Home Sales

  • Potential existing-home sales increased to a 6.04 million seasonally
    adjusted annualized rate (SAAR), a 0.3 percent month-over-month
  • This represents a 61.8 percent increase from the market potential low
    point reached in February 2011.
  • The market potential for existing-home sales increased by 3.4 percent
    compared with a year ago, a gain of 201,190 (SAAR) sales.
  • Currently, potential existing-home sales is 1.25 million (SAAR), or
    17.1 percent below the pre-recession peak of market potential, which
    occurred in July 2005.

Market Performance Gap

  • The market for existing-home sales is underperforming its potential by
    4.5 percent or an estimated 273,000 (SAAR) sales.
  • The market performance gap increased by an estimated 22,700 (SAAR)
    sales between February 2018 and March 2018.

Chief Economist Analysis: The Market Dynamics Fueling the Great
Housing Shortage

"In March, the housing market continued to underperform its potential.
Actual existing home sales are 4.5 percent below the market potential
for home sales, according to our Potential Home Sales model," said Mark
Fleming, chief economist at First American.

"The lack of supply is the primary culprit. The inventory of homes for
sale in most markets remains historically tight, yet demand continues to
rise as millennials further age into homeownership. Limited supply and
rising demand means house prices are surging, so why aren't more
existing homeowners selling their homes? Two market dynamics are at
play," said Fleming.

Market Dynamic 1: Locked to Your Mortgage Rate

"Many existing homeowners are ‘rate-locked.' The majority of existing
homeowners have mortgages with historically low rates and, now that
rates are rising, they are hesitant to sell their homes. They recognize
that once they sell and purchase a new home, they will have a higher
mortgage rate," said Fleming. "There is limited incentive to sell when,
due to higher mortgage rates, it will cost you more each month just to
borrow the same amount from the bank. As mortgage rates rise further,
more existing homeowners may become rate locked into their existing

Market Dynamic 2: Prisoner to the Market

"The root of the second dynamic at play is that the housing market is
not like most markets. Typically, the seller, or supplier, makes their
decision about adding 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, actually the same person –
the existing homeowner," said Fleming. "In order to buy a new home, you
have to sell the home you already own, and then find a home you like
better. Every home is different, an almost perfectly heterogeneous
product so, when supply is constrained like it is in today's market, it
becomes difficult to find a home better than what you already own.

"Potential 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 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," said Fleming. "However,
the risk of selling if others don't in a market with a shortage of
inventory prevents many existing homeowners from selling. The result is
prices are further bid up by competition for the increasingly short

"Our Potential Home Sales Model estimates the expected level of
existing-home sales based on market fundamentals. The market potential
for home sales based on current fundamentals is currently estimated to
be 6 million at a seasonally adjusted annualized rate (SAAR). The market
for existing-home sales is underperforming its potential by 4.5 percent
and this market performance gap is growing.

"The housing market is facing a deluge of demographically-driven demand,
and the greatest supply shortage in 60
years of record keeping
, according to the Federal Reserve Bank of
Kansas City," said Fleming. "The increasing pace of new construction,
particularly completions, will alleviate some of the supply shortage in
the longer run, but in the meantime there are two reasons why existing
homeowners have become prisoners in their own castles – the rate lock-in
effect and the seller's prisoner's dilemma."

What Insight Does the Potential Home Sales Model Reveal?

"When considering the right time to buy or sell a home, an important
factor in the decision should be the market's overall health, which is
largely a function of supply and demand. Knowing how close the market is
to a healthy level of activity can help consumers determine if it is a
good time to buy or sell, and what might happen to the market in the
future. That's difficult to assess when looking at the number of homes
sold at a particular point in time without understanding the health of
the market at that time," said Fleming. "Historical context is
critically important. Our potential home sales model measures what home
sales should be based on the economic, demographic, and housing market

Next Release

The next Potential Home Sales Model will be released on May 23, 2018
with April 2018 data.

About the Potential Home Sales Model

Background information on the First American Potential Home Sales Model
is available here.


Opinions, estimates, forecasts and other views contained in this page
are those of First American's Chief Economist, do not necessarily
represent the views of First American or its management, should not be
construed as indicating First American's business prospects or expected
results, and are subject to change without notice. Although the First
American Economics team attempts to provide reliable, useful
information, it does not guarantee that the information is accurate,
current or suitable for any particular purpose. © 2018 by First
American. Information from this page may be used with proper attribution.

About First American

First American Financial Corporation (NYSE:FAF) is a leading
provider of title insurance, settlement services and risk solutions for
real estate transactions that traces its heritage back to 1889. First
American also provides title plant management services; title and other
real property records and images; valuation products and services; home
warranty products; property and casualty insurance; and banking, trust
and wealth management services. With total revenue of $5.8 billion in
2017, the company offers its products and services directly and through
its agents throughout the United States and abroad. In 2018, First
American was named to the Fortune 100 Best Companies to Work
For® list for the third consecutive year. More information
about the company can be found at

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