Question #10 for 2022: Will inventory increase as the pandemic subsides, or will inventory decrease further in 2022?

Earlier I posted some questions on my blog for next year: Ten Economic Questions for 2022. Some of these questions concern real estate (inventory, house prices, housing credit, housing starts, new home sales), and I’ll post those in the newsletter (others like GDP and employment will be on my blog).

I'm adding some thoughts, and maybe some predictions for each question.

10) Housing Inventory: Housing inventory decreased sharply during the pandemic to record lows in early 2021.  Will inventory increase as the pandemic subsides, or will inventory decrease further in 2022?

This might be one of the most important economic questions for 2022!

Here are a few times when watching existing home inventory helped my analysis.

Starting in January 2005, I was very bearish on housing, but I wasn’t sure when the market would turn. Speculative bubbles can go on and on. However, the increase in inventory in late 2005 (see red arrow on graph below) helped me call the top for house prices in 2006.

Several years later, in early 2012, when many people were still bearish on housing, the plunge in inventory in 2011 (blue arrow on graph below) helped me call the bottom for house prices in early 2012 (see The Housing Bottom is Here).

Four years ago, in January 2018, I was quoted in a Bloomberg article that included a bearish outlook for housing. I disagreed, and the steady level of inventory helped (see orange arrow above):

Bill McBride, who runs the Calculated Risk blog and also called the crash, doesn’t think home prices are inflated this time around. Unlike in 2005, lenders are acting responsibly and the Wild West of real estate speculation hasn’t returned, he said. There is less to speculate on, too. Compared with the overbuilding that preceded the bust, today’s pace of construction isn’t fast enough, he said.

“Lending standards are still pretty good,” McBride said, and he doesn’t expect mortgage rates to “take off” in the short term.

And in December 2018, I disagreed with Professor Shiller A comment on Professor Shiller's "The Housing Boom Is Already Gigantic. How Long Can It Last?". My conclusion:

No big deal, and definitely not a "gigantic" boom in house prices.

In 2019, when several commentators were bearish on housing, I pointed out there was no sharp increase in housing inventory (like in 2005), and that was one of the reasons I remained optimistic on housing and the economy (correctly!).

And the sharp decline in inventory during the pandemic (green arrow) was an indicator that price appreciation would increase. Inventory declined due to a combination of potential sellers keeping their properties off the market during a pandemic, and a pickup in buying due to record low mortgage rates, a move away from multi-family rentals and strong second home buying (to escape the high-density cities). And at the same time, demographics were favorable for home buying (a large cohort has moved into the peak home buying years).

According to the National Association of Realtors® (NAR), inventory decreased to 1.11 million in November from 1.23 million in October. Note that inventory was already pretty low in 2017, 2018 and 2019.

Prior to 2020, two of the key reasons inventory was low:

1) A large number of single-family home and condos were converted to rental units. In 2015, housing economist Tom Lawler estimated there were 17.5 million renter occupied single family homes in the U.S., up from 10.7 million in 2000. Many of these houses were purchased by investors. Most of these rental conversions were at the lower end, and that limited the supply for first time buyers. 

2) Baby boomers are aging in place (people tend to downsize when they are 75 or 80). The leading edge of the boomers are now turning 76 or so, and the boomers selling will probably gradually increase over the next 10 years (see: Housing and Demographics: The Next Big Shift)

Inventory is not seasonally adjusted, and usually inventory decreases from the seasonal high in mid-summer to the seasonal lows in December and January as sellers take their homes off the market for the holidays.

The second graph shows the year-over-year (YoY) change in reported existing home inventory and months-of-supply. Note: Months-of-supply is based on the seasonally adjusted sales and not seasonally adjusted inventory.

Inventory was down 13.3% year-over-year in November compared to November 2020.  Months-of-supply at 2.1 months in November is very low, but still above the record low of 1.9 months set in December 2020 and January 2021. That record will be tested next month.

In 2020, inventory really declined due to a combination of potential sellers keeping their properties off the market during a pandemic, and a pickup in buying due to record low mortgage rates and favorable demographics (a large cohort has moved into the peak home buying years), a move away from multi-family rentals, and strong second home buying.  In 2021, mortgage rates remained low, demographics remained favorable, and we saw a significant increase in investor buying.

Alternative measures of inventory

Mostly I focus on inventory as reported by the NAR.  However, I also look at inventory from local markets (this showed inventory was down about 26% year-over-year).

Another source is Altos Research that tracks inventory weekly.  

This inventory graph is courtesy of Altos Research.

As of December 17th, inventory was at 326 thousand (7-day average), compared to 454 thousand for the same week a year ago. That is a decline of 28.2%.

As housing economist Tom Lawler has noted, the local MLS data shows even a larger decline in active inventory (the NAR appears to include some pending sales in inventory). Lawler noted:

"As I’ve noted before, the inventory measure in most publicly-released local realtor/MLS reports excludes listings with pending contracts, but that is not the case for many of the reports sent to the NAR (referred to as the “NAR Report!”), Since the middle of last Spring inventory measures excluding pending listings have fallen much more sharply than inventory measures including such listings, and this latter inventory measure understates the decline in the effective inventory of homes for sale over the last several months."

Although the NAR is reporting inventory is down 13.3% YoY, it is very likely that active inventory is down 26% to 28% YoY.

Conclusion

First, it appears we will see record low inventories over the next few months. This suggests we will see further strong price gains over the next several months (with low inventories).

In 2021, the NAR showed inventory bottomed in January and (inventory bottoms in December), however the local MLS data, and the Altos Research data, showed inventory bottomed even later than usual - in March or early April 2021.  If 2022 follows the normal seasonal pattern, we will see inventory increasing by February (and maybe even in January).   

The timing of the seasonal bottom will be important this year.  If inventory bottoms seasonally in December, we might see inventory increase YoY later in 2022.  However, if inventory doesn't bottom until March or April, we will probably see another crazy year with little inventory.

Second, the outlook depends on the course of the pandemic.   Each new wave of the pandemic has driven down interest rates, and that has made homebuying more affordable (even as prices increased sharply).   Making the assumption that the pandemic will be mostly over by mid-2022 (due to a combination of vaccines and therapeutics), we can make a few general predictions:

1. Mortgage rates will increase in 2022 (from the current 3.25% for a 30-year fixed rate), and this will make house prices less affordable.  This should dampen some of the buying frenzy.

2. Sellers will be more willing to list their homes as the pandemic subsides, and price increases slow.

The bottom line is inventory will probably set new record lows over the next couple of months, and then inventory will likely increase YoY later in the year.   However, it seems unlikely that inventory will be back up to the 2017 - 2019 levels.   Inventory is always something to watch!

Ten Economic Questions for 2022

• Question #1 for 2022: How much will the economy grow in 2022?
• Question #2 for 2022: Will the remaining jobs lost in 2020 return in 2022, or will job growth be sluggish?
• Question #3 for 2022: What will the unemployment rate be in December 2022?
• Question #4 for 2022: Will the overall participation rate increase to pre-pandemic levels (63.4% in February 2020)?
• Question #5 for 2022: Will the core inflation rate increase or decrease by December 2022?
• Question #6 for 2022: Will the Fed raise rates in 2022? If so, how many times?
• Question #7 for 2022: How about housing starts and new home sales in 2022?
• Question #8 for 2022: Housing Credit: Will we see easier mortgage lending in 2022?
• Question #9 for 2022: What will happen with house prices in 2022?
• Question #10 for 2022: Will inventory increase as the pandemic subsides, or will inventory decrease further in 2022?