It is generally accepted in real estate that a “balanced market” has about six months’ worth of inventory. In other words, the sales for that month are equal to one-sixth the number of properties listed, so, all things being equal, it will take six months to clear that inventory. As Norada Real Estate Investments calls it,
“As a general rule, 5 to 6 months of inventory is considered a normal or balanced market. Over 6 months of inventory and we have a buyer’s market. If it’s less than 5 months and we have a seller’s market.”
Even the National Association of Realtors tells “Historically, six months’ supply has been associated with moderate price appreciation.”
What’s immediately odd in this is that despite it being a seller’s market, housing prices have declined over the past year. In May 2023, prices were down 2.2% From its peak in June 2022 at the national level. Also, the inventory was only half of the “balanced market”. 3.0 months in May 2023,
In fact, looking at average days on market in Jackson County, Missouri (the largest county in the Kansas City metro area, where I invest), it becomes abundantly clear that inventory is quite low. It has taken no more than a month on average to get a property under contract since before the pandemic.
Nationwide, the trend is not much different. Average time to market for a listed property in May 2023 was only 43 days old And in many years there had not been more than three months.
It is difficult to measure this market
Now admittedly, it’s a strange market, and it may explain why prices are falling despite it being a “seller’s market,” given the amount of inventory available. Prior to the rate hike last year, prices were rising to unheard-of levels. Those rate hikes made it more expensive for anyone using the loan to buy a home, which put pressure on prices. Still, because most homeowners have low-interest, fixed mortgages, there’s little incentive to sell. Thus, while there are fewer buyers at these prices with these rates, New listings falling sharplyWhich drives up house prices by keeping the supply low.
This dynamic is quite strange, to say the least.
Nevertheless, one would expect that if there is six months’ inventory in a “balanced market” and such a market brings “moderate price appreciation”, and instead, the actual inventory is half that, then prices would rise or, at an absolute minimum, , not fall.
And remember, prices have fallen in nominal terms. In real terms (taking into account inflation) they have decreased by about 10%.
It appears that our idea of a “balanced market” needs to be adjusted.
Part of the problem may be that historically speaking, the average supply of inventory for new home sales has actually been about six months, if not more.
However, the majority of home sales are not new construction. “Existing homes, as opposed to new homes, are homes that are owned and occupied before they hit the market.” And such sales paint a very different picture. (However, strangely, Fed data The monthly supply for existing homes is only till May 2022.)
And as far as valuing the housing market goes, existing home sales are a better indicator than new home sales. For example, in March 2023, the annual rate of sales of an existing home was 4.43 million, Same annual rate for new home sales 683,000, And if anything, the difference between the two is usually large.
Luckily, Bill McBride arrived calculated risk There is long-term data on existing home inventory. And as you can see, since the beginning of the century, with the exception of the Great Recession and its immediate aftermath, inventory (the red line) has hardly ever exceeded 4 months.
One may object that the real estate market has been hot for some time now and it was definitely hot in the early days before the 2008 financial crisis. So just because there’s been about four months or less of inventory over the last 20 years, it could just be because the market was mostly a seller’s market for the last 20 years.
There is some truth in this, but still, isn’t it a little strange that the only time this century housing inventory exceeded the “balanced market” was the real estate-driven financial crisis worse than any seen since 1929. Was it worse than the crisis? This implies that our concept of a “balanced market” should be a month or more out.
There is also another problem. Prices and inventory are not nearly as correlated as we think. during the financial crisis, median home prices peaked in the first quarter of 2007, then bottomed out in the first quarter of 2009, and rose almost uninterrupted thereafter. Nevertheless, inventory levels did not drop below six months until 2012.
Then, as now, home price increases and inventory levels associated with a buyer’s and seller’s market were inverse. The same was true for most of 2006.
conclusion
Of course, no rule of thumb is ever perfect when it comes to interpreting the market. In a complex economy like ours, there are too many factors involved, no single rule can do it.
That being said, it should be clear that one, a “balanced market,” is probably closer to four or at most five months of inventory than the typically stated six months, and two, the number of months of inventory. is of limited value when it comes to understanding prices.
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Note by BigPockets: These are the views expressed by the author and do not necessarily represent the views of BiggerPockets.
