Real Estate Mathematics

Tuesday, August 15, 2006

A housing market is like the economy - there can be leading indicators of direction and lagging indicators. Many people use current housing prices as their sole indicator not knowing that this is a lagging indicator, and then crying.

For the first lesson, let us look at the numbers available from many multiple listing services as monthly reports. The first number to look at is Inventory of houses for sale. If there is a large inventory then it's a buyer market, if there is a small inventory it is a seller's market.

The image above is from and shows the inventory in the Seattle area over three years. The inventory levels dropped from 2003 to 2004, indicating a hot market. In 2005 this pattern continued until October, 2005 when inventory started climbing -- the market was cooling each month more.

What about housing prices... from the same report we see a different situation.
King Country Sales
Although inventory is growing - suggesting a slowing, the sale prices do not reflect this! Why?
There are a few clear reasons:

  • A sale may take 60-120 days to close. What you are seeing are the offer price from month earlier!
  • Buyers tend to be slow to pick up on a change of inventory -- being focused on the price and not the inventory.

This means that sales price is a lagging-indicator that is typically 3-6 months behind the market conditions. House inventory is a leading indicator, it reflects changes almost as soon as the market changes.

Another indicator that is a more complex to intrepretate is new listings. An example is shown below:

What we see is interesting, there was a surge of new listings starting in August 2005. These new listings came on too fast to clear on the market. The problem is why they occurred?

Was it new units that were built for the hot market? Has a magic point happened that caused people to want to capture their gains? Was it people realizing that they were over-extended because of interest rates and wanting to get out?

So what do we have as our first lesson? Three indicators:
  • Change of New Listings (most lead) - complex interpretation
  • Change of Total Inventory (leading) - clean interpretation
  • Change of Sale Price (lagging) - clean interpretation


Blogger RonS said...

Just wanted to stop and say Thanks for the great blog. Nice to see so much thought (and research) behind your article.

11:05 PM  

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