It has been generally accepted in real estate that a “balanced market” has about six months of inventory. In other words, this month’s sales are 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 says it,
“Generally, 5-6 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 stipulate that “Historically, six months of supply is associated with moderate price appreciation.”
What’s immediately strange about this is that house prices have fallen since last year despite what should be a seller’s market. In May 2023, prices were down 2.2% nationwide since peaking in June 2022. At the same time, stocks were only half that of a “balanced market,” sitting at 3.0 months in May 2023.
Indeed, just by looking at the average days on market in Jackson County, Missouri (the largest county in the Kansas City metro area, where I invest), it becomes quite evident that stocks are quite low. It hasn’t taken more than a month on average to get a property under contract since before the pandemic.
Nationally, the trend is not much different. In May 2023, the median time to market of a listed property was only 43 days and had not exceeded three months for many years.
Gauging this market is difficult
Admittedly, this is a strange market, and this may partly explain why prices are falling when it is a “seller’s market”, given the amount of inventory available. Prices were rising to unprecedented levels before the rate hikes last year. These rate hikes made it much more expensive to buy a home for anyone in debt, putting downward pressure on prices. Yet, with the vast majority of homeowners on low-interest fixed mortgages, there is little incentive to sell. So while there are fewer buyers at these prices with these tariffs, new registrations are down sharplywhich supports house prices by keeping supply low.
This dynamic is quite strange, to say the least.
Yet, one would expect that if a “balanced market” consisted of six months of inventory and such a market tended to result in “moderate price appreciation”, and that instead the ‘actual inventory was half that, prices would rise or, at the absolute minimum, not fall.
And remember, prices have fallen in nominal terms. In real terms (taking inflation into account), they are down about 10%.
So it would seem that our idea of what a “balanced market” is needs to be adjusted.
Part of the problem may be that historically speaking, the average supply of inventory for new home sales has indeed been around six months, if not longer.
However, most home sales are not new construction. “Existing homes, unlike new homes, are homes that are owned and occupied before they are put on the market.” And these sales paint a very different picture. (Curiously, however, Fed data for the monthly supply of existing dwellings dates back only to May 2022.)
And when it comes to housing market valuation, existing home sales are a better indicator than new home sales. In March 2023, for example, the annualized rate of existing home sales was 4.43 million. The annualized rate of new home sales was only 683,000. And if anything, the gap between the two is normally larger.
Fortunately, Bill McBride at Calculated risk has long-term data on the inventory of existing homes. And as you can see, since the turn of the century, with the exception of the Great Recession and its immediate aftermath, the inventory (red line) has almost never exceeded 4 months.
One could counter that the real estate market has been hot for some time now and was certainly hot in the early years leading up to the financial crisis of 2008. So just because the last 20 years have been mostly around four months of inventory or less, it may just be because the market was primarily a seller’s market for the past 20 years.
There’s some truth to that, but still, isn’t it a little odd that the only time in this century that housing inventory has exceeded a “balanced market” was in a real estate financial crisis worse than anything seen since 1929? This strongly implies that our “balanced market” concept is about a month higher than it should be.
There is also another problem. Prices and stocks are not as correlated as one might think. During the financial crisis, median house price peaked in the first quarter of 2007, then bottomed out in the first quarter of 2009 before rising almost continuously thereafter. Yet inventory levels did not fall below six months until 2012.
Then, from now on, home price appreciation and inventory levels associated with a buyer’s and seller’s market were inverse. It was the same for most of 2006.
Of course, no rule of thumb will ever be right when it comes to explaining a market. There are too many factors involved in a complex economy like ours for just one rule to do.
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 six months normally asserted, and second, the number of months of inventory has limited value when it comes to understanding prices.
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Note by BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.