The Housing Shortage Explained | Seeking Alpha

Real Estate Market Crash - Falling Home Prices

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The Housing Shortage has been one of the most popular stories in real estate and the economy over the last year. Everywhere you look, you see headlines about the lack of inventory driving up home prices. Many people actually said that home prices would not fall because the inventory situation was so tight. But now, with many indications that home prices are already falling, the housing shortage narrative is feeling a bit shaky.

In this article, I’m going to explain the true inventory situation in the U.S. housing market and what it means for home prices over the next 6-12 months.

The U.S. Single Family Home market is a very important part of the U.S. economy. At the end of 2022, total single-family home sales are trending towards an annual pace of 4.8 million.

Total Home Sales

NAR, Census Bureau, EPB Research

Of the 4.8 million total home sales, 87% are existing home sales, and about 13% are new home sales. As the name suggests, existing home sales are homes that have a current owner, and new home sales are homes without an existing owner, a newly constructed unit.

The total volume of home sales has been declining over the past year. At the end of 2020, the pace of single-family home sales was over 7 million. So, the volume of transactions is down from 7 million to 4.8 million, a decline in volume of 2.2 million units or 31%.

So, demand is dropping, and this is because mortgage rates have increased rapidly, making homes completely unaffordable at these very elevated prices. There are many people who say even though the volume of transactions is declining, home prices still won’t fall because there is no supply. So, demand is falling, but there’s even less supply.

The best measurement of supply and demand balance for real estate is called the “months’ supply.” The months’ supply takes the total inventory or how many houses are for sale, divided by the current pace of sales. So, if there are 5 houses for sale and you sell 1 house per month, the months supply would be 5.

It would take 5 months for all the houses to sell.

Whenever the monthly supply of U.S. housing is below 5, that is considered a tight market where prices will rise. When the months supply starts to rise above 6, prices began to soften and even fall.

Months Supply

NAR, Census Bureau, EPB Research

The months’ supply of the total U.S. housing market is currently 4.0. A months’ supply of 4.0 is very tight. So what most people are doing is they are looking at this months supply number and saying home prices can’t fall.

If we look at a scatter plot with the months supply of U.S. housing on the bottom axis and the rate of home price growth six months in the future on the left, we can see that with today’s monthly supply reading of 4.0, implies six months from now home prices will be rising something close to an 8% annual rate.

Home Price Declines

NAR, Case Shiller, Census Bureau, EPB Research

So what everyone is doing is taking this months’ supply number and suggesting, based on the data, home prices will rise, even though demand is slowing sharply.

There is more nuance to this story. We have evidence that home prices are already falling. The Case Shiller National Home Price Index was reported for August and showed home prices falling at a 4% annualized rate, a complete collapse from the 25% price gains seen at the start of 2022.

We are seeing price declines for the first time in over ten years, so something is going on. How could home prices be falling with such a low months’ supply?

National Home Prices Falling

Case Shiller, EPB Research

The total months supply number of 4.0 is made up of a months’ supply of 3.2 for existing homes and 9.2 for new homes.

A big difference.

Months Supply

Census Bureau, NAR, EPB Research

The months’ supply of existing single-family homes fell to a record low of 1.5 at the start of 2022, an insanely unhealthy situation for the housing market. In 2021 and early 2022, mortgage rates fell to 2.5%, a level no one thought was possible, which caused a massive wave of refinances.

Months Supply Existing Homes

NAR, Census Bureau, EPB Research

Everyone locked in that 2.5% rate. Now, with mortgage rates over 7%, if you hold an existing mortgage at 2.5%, then you will never sell your house. Selling your house would mean giving up your 2.5% rate and trading it for a 7% rate; no one would do that unless they were forced, so there is a massive amount of existing home inventory that is completely trapped and will never come to market. Because existing home sales are 87% of the total, this is keeping the inventory number depressed.

Months Supply

NAR, Census Bureau, EPB Research

New homes are a different story. New homes don’t have a previous owner and are usually sold by companies that don’t like to hold inventory for too long. The months’ supply in the new home market is rising to the highest level since the 2008 period, as the demand for homes has dried up due to 7% mortgage rates.

Months Supply

NAR, Census Bureau, EPB Research

Several months ago, we saw homebuilding companies offering big concessions on their home sales. They would try and keep the sales price the same but offer some perks to help reduce the effective cost of the transaction. Those concessions quickly turned to price cuts. In September, the NAHB home builder sentiment survey told us that 24% of builders reported price cuts. The home builder sentiment index fell again in October, so that 24% number is likely even higher.

NAHB Home Builder Survey

NAHB

Homebuilders are swamped with excess inventory and are cutting prices. If we run the same correlation between future home price growth and the months’ supply of new homes, we actually see an improved relationship, a better fit. At a months’ supply of 9.2 in the new home market, that implies six months from now, home prices will be falling nationally at about a 5% annual rate.

Home Price Growth

NAR, Census Bureau, EPB Research

So, the inventory situation in the U.S. housing market is very nuanced. Total inventory is very low, but this is heavily skewed by existing homes. There is no inventory for existing homes because no one wants to give up their 2% mortgage. The homebuilders, the speculators, the flippers, and the people that don’t like to hold inventory for very long are seeing months’ supply spike.

So what number should we trust? Total inventory or new home inventory? The correlation is better with new homes, but existing homes are a larger segment of the market.

In my opinion, home-building companies are price setters. They will only hold inventory on their books for so long. Eventually, builders will sell homes for reduced prices, and this will cause all home prices to be valued lower from the comparison effect.

If you are in the market for a home, perhaps consider a new home where it’s definitely a buyers’ market.

The supply situation is very different in the new home market. Price cuts are happening all across the new home market, and this is set to continue as supply and demand are still out of balance. These price declines for newly constructed homes will cause the prices in the existing home market to fall as well, even though supply is remaining tight there.

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