Why the ‘Big Short’ in Housing Supply Will Remain in 2021

Economics is all about supply and demand. In the housing market right now, there’s plenty of demand—but not a lot of supply. And, according to First American Financial Corp., that’s not likely to change any time soon.

Mark Fleming

“Rapid nominal house price appreciation has finally outpaced the house-buying power benefit from historically low mortgage rates,” wrote First American Chief Economist Mark Fleming in a commentary this week. “The low rates have helped fuel the surge in demand since April in a housing market that is desperate for supply, which is Econ 101 for faster house price appreciation that out-competes rising house-buying power.”

Since 1991, on average, 2.5 percent of the stock of homes are for sale in any single month. Throughout 2019 and preceding the pandemic, average inventory was 1.65 percent, but the pandemic-induced supply contraction further reduced average inventory to nearly 1.4 percent in April. Fleming noted inventory turnover – the total supply of homes for sale nationwide as a percentage of occupied residential inventory – was low prior to the pandemic, but began to drop precipitously starting in April. Since then, average inventory has steadily declined to 1.3 percent. That means only 130 homes in every 10,000 are for sale, compared with almost double that amount in normal times.

Additionally, Fleming said existing home sales make up 90 percent of all home sales; in October the seasonally adjusted months’ supply for existing homes hit a historic low of 2.5 months. As existing homeowners have withdrawn supply, average tenure length – the amount of time someone lives in their home – has soared to a historic high of 10.5 years.

“Ultimately, rising tenure length means there are fewer homes on the market and as demand has surged the competition among home buyers for the small amount of homes for sale drives prices up,” Fleming said.

Home builders have responded to the supply shortage—but it won’t be enough. In October, housing starts increased 14 percent compared with a year ago, and new home sales reached one million  in September and October. “This is a positive sign of potential new supply under construction, but it’s unlikely to change the supply dynamic quickly,” Fleming said. “The U.S. housing supply has been underbuilt for over a decade and it will take years of accelerated new home construction to close the gap.”

There are silver linings, however—and not just in the pockets of mortgage lenders and servicers, who, according to the Mortgage Bankers Association’s quarterly Mortgage Bankers Performance Report (see story below), enjoyed one of their best third quarters ever. Fleming said despite the challenging economic conditions for many households, for those fortunate enough to continue to have stable income, house-buying power is the highest its ever been because of historically low mortgage rates.

“As more and more potential home buyers rush to take advantage of sub-three percent mortgage rates in an environment of limited homes available for sale, multiple-offer bidding wars become the norm and prices are pushed higher,” Fleming said. “Mortgage rates are expected to remain low for the foreseeable future and millennials will continue forming households, keeping demand robust, even if income growth moderates. Despite the best intentions of home builders to provide more housing supply, the ‘big short’ in housing supply will continue into 2021 and likely keep house price appreciation flying high.”