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The Rise of Housing Obsolescence and Shadow Demand

Inventory of Existing Homes For Sale May Be Increasingly Non-Desirable

Mark Fleming    |    Housing Trends

This week, new and existing home sale estimates for March were released by the U.S. Census Bureau and the National Association of Realtors (NAR). New home sales were down 13.3 percent and existing home sales were down 7.5 percent, both from a year ago. On Wednesday, the Mortgage Bankers Association released its weekly application survey, which also showed a decline in purchase applications of 18 percent year over year. Most market prognosticators were hopeful that heading into the spring buying season, housing would continue to show strength. So why does it seem that the market is slowing relative to this same time last year?

NAR Chief Economist Lawrence Yun was recently quoted in an interview with Forbes Magazine expressing his concern about the historical underperformance of sales activity and points to one particular problem:

“There really should be stronger levels of home sales given our population growth,” he said. “In contrast, price growth is rising faster than historical norms because of inventory shortages.”

The lack of inventory is a key issue in this recovery cycle. There are only 2 million existing homes for sale, which is similar to the level of inventory in the early aughts. There are even fewer homes for sale that do not suffer from housing obsolescence – properties that are no longer desirable because their characteristics do not match what buyers are looking for in a home. For example, homes that are located in once, but no longer, popular locations, or homes that are lacking the local amenities sought by today’s buyers. Many of these now obsolete homes are in the inventory as a result of the housing and financial crisis. Therefore, the inventory or homes for sale that buyers actually want to purchase is even less than what's on the market now, and many people who are looking (and qualified) to buy a home are holding off because they can't find the right one. Just as shadow inventory is the stock of properties in delinquency or foreclosure that are not yet for sale, these buyers waiting in the wings are the new “shadow demand.”

How do we know that housing obsolescence is on the rise?  In the chart, the ratio of the average days on market (DOM) for all homes in the active inventory to the average DOM for sold homes is shown over time. The higher the ratio, the longer the DOM for all homes relative to the DOM for sold homes, which indicates that a portion of the inventory is languishing, unsold. In fact, homes that sell are on the market for only about two-thirds the amount of time as the overall inventory average. In 2007, there was barely any difference between the DOM for sold homes versus the entire active inventory.

Out of necessity, the housing and financial crisis has led to new measurements that previously weren’t regularly monitored. It required us to start measuring negative equity, to develop the concept of shadow inventory, and now, to pay attention to the obsolescence of the active inventory of homes for sale. If we think that 2 million homes on the market is low, increasing housing obsolescence makes the actual viable inventory even less. Maybe the reason that home sales aren’t increasing is because buyers can’t find anything they want to buy. More viable homes for sale are needed to draw this demand out of the shadows.

Gilberto Mendez contributed to this post.

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