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More People Will Buy Homes if Prices go Up, Wait… What?

by devteam October 26th, 2013 | Share

While it seems counterintuitive, could higher home prices lead an increasernin home sales?  Two Federal Reserve Bankrnof San Francisco senior economists, William Hedberg and John Krainer think sornas explained in an Economic Letter titled WhyrnAre Housing Inventories Low?  It’s not that higher prices will entice buyers, but rather, they may motivate sellers to help increase inventory.</p

For-sale inventories have been slow to rebound from the Great Recession evenrnthough home prices have increased steadily since 2012.  Hedberg and Krainer theorize that prices arernstill not high enough to entice many sellers. rnFor some this is because the value of their home is still below thernoutstanding balance on their mortgage, meaning that sellers would have to bringrncash to the closing.  For others it mayrnbe that their equity is not back to a level that motivates them to sell. </p

Economic theory suggests that all homes are for sale if the pricernis right, but at any point in time, the price may not be right. Sellers haverntheir own ideas about what is “right” and must also consider that selling arnhouse can be costly because of brokerage fees, and necessary or cosmeticrnchanges to the house.  For these reasonsrnand others the active listing a home is viewed by economists as a strong signalrnof an intent to sell and they measure the short-run supply of homes for sale,rnthe inventory, by the listing numbers. </p

Good times or bad, there is always some level of inventory in the housingrnmarket.  Some owners sell to move up,rnothers to downsize, other move for employment reasons, or to free up cash.  These are life-cycles motives not necessarilyrntied to the business cycle and produce a general level of churning in thernmarket.  Nevertheless the authors sayrnthere is a distinct cyclical pattern to inventories which rise in good timesrnand fall in bad times.   </p

Credit conditions, which are also cyclical, can account for some ofrnthis.  Risk premiums charged by lendersrnand their willingness to lend tend to ease during good economic times, allowingrnmore potential buyers to enter the market. But it is the level of house pricesrnwhich is by far the variable that most influences the inventory of homes forrnsale.</p

Even though not all listed homes are vacant Census Bureau data on thernnumbers and price level of vacant homes have a long history of indicating thernrelationship between inflation-adjusted house prices and for-sale inventory.  As Figure 1 shows, inventories generally movernwith prices and changes in house prices have a causal effect on inventories.  The two series are tied together in arnlong-run relationship and the authors say this makes sense as rising housernprices should encourage homeowners to sell and thus inventories to rise.</p

fig. 1</p

</p

Inventories do not instantly react to house price changes and otherrneconomics can disrupt the price/inventory relationship as is evident in thernmost recent time period in the figure above. rnHouse prices have been recovering broadly since 2012 but inventoriesrnhave been declining.  Only recently havernthey begun to rise. </p

The relationship between inventory and prices may have broken down for anrnextended period as the market rebounded in 2012 because of fallout from the housingrnboom and bust.   The boom saw an unprecedented rise inrnhomeownership rates with younger households more willing to buy and eased lendingrnallowing in less qualified borrows.  Whenrnthose trends reversed the inventory shifted from homes for sale to homes forrnrent with the later rising steadily during the recession and the for-salerninventory dropping and only recently stabilizing.</p

The authors say the data does not go back far enough to show ifrnthis is a typical reaction but some Census Bureau data suggest it is unprecedentedrnsince the 1960s.  The phenomenon isrnwidespread and cannot be accounted for solely by the surge inrnforeclosures.  The inventory of homes in foreclosurernhas recently been falling in most markets but the ratio of owner occupied andrnrenter occupied units has remained down. Thus, either preference forrnhomeownership has shifted or, more likely, credit constraints have affectedrnhousehold home purchase decisions. </p

The changes in for-sale and for-rent inventories are seen most dramaticallyrnin markets like Las Vegas, Phoenix and Miami where foreclosures were high andrninvestors have been buying large numbers of the foreclosed properties.  In these market the total inventory of homesrnfor rent is approaching that of homes for sale, a remarkable shift that hasrncontinued throughout the recovery.  But,rnin addition to the investor-effect the decline in homes for sale is veryrnclosely linked with the large downward shift in the homeownership rate in thesernmarkets. It is impossible to say though whether declining sales are pushingrndown homeownership rates or falling homeownership is pushing down sales, orrnboth are interacting with each other in a complicated feedback process.</p

</p

Tight credit conditions may be affecting both the ownership decisions of<byoung buyers and the supply side of the market. rnIn theory, falling house prices alone may keep some homeowners fromrnselling. It may seem logical that decisions to sell should be based only onrninformation about current and future market conditions and the authors point tornresearch that shows homeowners take more time to sell if home prices havernfallen since the original purchase. That is, two similar homeownersrnexperiencing similar housing market conditions will behave differently if onernof those homeowners has an unrealized loss on his or her house.</p

Falling prices may hold down home sales for several reasons. An underwaterrnhomeowner may be unwilling or unable to make up the difference between salernproceeds and mortgage balance and chose to delay selling.  Even if there is equity, it may be reducedrnenough that no cash is available for the downpayment on another home. </p

Since early 2008, homes for sale and homes underwater have been negativelyrncorrelated.  Counties with a high sharernof underwater mortgages have tended to have smaller for-sale inventories.  The authors say that while this relationshiprnis significant, its strength diminished as the recovery got under way.rnUnderwater borrowers may have been locked into their houses in a way that<bimpaired the normal functioning of the housing market. But that effect seems tornbe waning.</p

</p

Another explanation for this breakdown is that homeowners may berntaking a longer view of the market.  Inrnthe housing cycle price changes are persistent, that is both price rises andrnprice drops are likely to be followed by more of the same.  Homeowners who can be flexible on timing arnsale can take advantage of this persistence, waiting and gambling thatrnincreases will continue and they can sell at a higher price.</p

Figure 4 confirms on a county level the negative relationship between pricesrnand inventories shown at the aggregate level in Figure 1. Where countiesrnexperienced relatively large price increases they also saw for-sale inventoriesrndecline. </p

</p

The authors say it turns out that that variables such as recent house pricernappreciation and changes in employment are the most robust predictors of recentrnchanges in housing inventory. Once these are accounted for other variables,rnsuch as changes in the for-rent inventory, the underwater share, or localrnprice-rent ratios, do little to explain the inventory of houses for sale. “Thus,rncurrent homeowners may be making a rational choice to postpone selling in thernhope that prices will rise further. However, this behavior tends to be shortrnrun. In the longer run, the link between the level of house prices and for-salerninventories is strong. If prices continue to rise, inventories for sale shouldrneventually rise too.”</p

Conclusion</p

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

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About the Author

devteam

Steven A Feinberg (@CPAsteve) of Appletree Business Services LLC, is a PASBA member accountant located in Londonderry, New Hampshire.

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