A REALTOR® once told me, “If you ever want to lose somebody at hello, just say ‘statistics.’” Maybe the same can be said for “economics” – but tuning out fundamental economic concepts like supply and demand turns a blind eye to forces that shape the price of everything. Most people pay attention to the bottom line if the price is big enough. The price of real estate certainly gets buyers’ and sellers’ attention, so the economics behind it matters.
The bottom line for price is that it’s dictated by a meeting of minds between sellers and buyers. REALTORS® know that without that, there’s no deal. Who knew basic economics could be so simple and intuitive?
Of course, getting agreement on the price at which real estate can trade hands is rarely simple. That’s because psychology and expectations play such a major role. Many factors influence psychology and expectations, including the news media, family, and friends. Mindset affects both buyers and sellers, and can affect entire markets when a big enough group of buyers and/or sellers hold a similar mindset.
Predicting shifts in prevailing crowd psychology among buyers and sellers with any precision is difficult to say the least. However, the monthly trend for the number of months of inventory provides an important glimpse into the near future for price trends.
The number of months of inventory reflects how long it would take to completely liquidate inventories at the end of the month given current sales activity. The monthly trend for months of inventory is the thing to watch. If its trend drops to unusually low levels and stays there, demand is outstripping supply and big price increases should be expected. If its trend climbs to abnormally high levels and stays there, price stagnation and erosion is likely. The longer the trend persists, the more likely an outright price correction may occur.
In the absence of an economic shock, like an abrupt and lasting drop in employment, supply declines in response to lower demand. If supply falls quickly enough, an outright price correction is prevented. In the absence of financial distress or other motivation, sellers unwilling to accept offers too far below asking price either hold out awaiting “the right buyer” (i.e. one whose offer comes close enough to asking) or they take it off the market until demand improves. Whether the listing is taken off the market once it expires or languishes on the market unsold, supply effectively declines until there’s a shift in buyer and/or seller mindset when it comes to price. That’s why real estate prices are, in the parlance of economists, “sticky downward” as sales activity recedes.
Few sellers are eager to accept offers well under what their neighbour sold for (presuming their homes are reasonably comparable). A major and sudden price correction requires more sellers to drop their asking price en masse than is typically the case in the absence of an economic cataclysm.
While the timing as to where in a housing market cycle one buys and sells matters, typical real estate market dynamics in a growing economy mean that prices don’t go down as much as they go up over the long term. REALTORS® know this. Everybody else should too.
