It’s All About Supply and Demand
Definitions of Supply and Demand:
In classical economic theory, the relation between these two factors determines the price of a commodity. This relationship is thought to be the driving force in a free market. As demand for an item increases, prices rise. When manufacturers respond to the price increase by producing a larger supply of that item, this increases competition and drives the price down.
A theory explaining the interaction between the supply of a resource and the demand for that resource. The law of supply and demand defines the effect that the availability of a particular product and the desire (or demand) for that product has on price. Generally, if there is a low supply and a high demand, the price will be high. In contrast, the greater the supply and the lower the demand, the lower the price will be. The law of supply and demand is not an actual law but it is well confirmed and understood realization that if you have a lot of one item, the price for that item should go down.
In real estate appraisal context, the principle of Supply and Demand states that:
The price of real property varies directly, but not necessarily proportionately, with demand and inversely, but not necessarily proportionately, with supply.
My most simple explanation of Supply and Demand is: It is the relationship between sellers present in a market, which is the supply; and buyers looking, which is the demand. This relationship is reported in months’ supply of inventory.
So, what is the latest challenge?
Some (or most) might say that there are not enough “good” homes for sale. This could represent a shortage of supply, something we have not talked about for several years. It is allowing sellers to raise their asking prices and buyers who have been ‘shopping around’ are now willing to pay higher prices based on other homes they are comparing and/or contemplating to the home that they want.
Why do we have a shortage?
- We are coming out of the worst decline (or correction) in real estate values for many generations – some pointing back to the early 1980′s, others are pointing back to the Great Depression.
- In all of Chicagoland, our MLS showed a 37.6% decline in 5 years. The values hit their all-time high in the 3rd quarter of 2007 at $391,272, and by the 3rd quarter of 2012, they hit a low of $244,203.
- The mean sales price at the end of the year in 2001 was $239,858, and year-end 2002 was $255,001. Therefore pricing as of the end of 2012 is at the same level that we were 10 years ago – sometime in 2002.
Why aren’t there many “good” homes for sale?
There are several contributing factors:
1. New construction – We are seeing new construction picking up again at all price points, which is certainly a positive. But with fewer builders, and more conservative approaches after getting burned, builders are not keeping up with the demand that is present. This is leaving buyers searching for resales. And because of the slowdown in new construction, (few new homes were built between 2007 and 2012) the nearly-new resales rarely exist.
Lack of new construction is a contributing factor as many builders folded or downsized significantly over the past 5-6 years.
2. Foreclosures – Foreclosures are a trend that is affecting supply of inventory. Banks are slower at foreclosing, in some cases taking over 3 years through the process. In some cases, the buyers aren’t even interested in these properties, and the investors are picking up these properties and flipping them at a profit.
Foreclosure properties, once viewed as a deal perhaps 25% to 40% under market values, are now being sold at only a 7% discount according to RealtyTimes.com.
3. Investors – Investors have entered the market at greater levels, some to purchase properties to rent, others to rehab and flip them. With the high inventory, investors were able to seek out the best deals, now there are fewer homes available for them.
4. Few people really want to sell at the bottom – Personally, I think the biggest reason that our inventory is low is simply because everyone wants to buy at the bottom; but what seller really wants to sell their home at the bottom of the market? That being said, there are many sellers who cannot sell.
Recently, I heard Steve Harney speak at the Leading Real Estate Companies of the World Conference; he stated there are over 10 million people that are still under water and cannot sell their homes. That is a significant number – these are ‘move-up buyers’ that will create a domino effect. A portion may also represent the potential downsizing buyers who have that upper priced home to sell. This is a very complicated situation. There are many opportunities in the market as demand continues to surge.
Move-up sellers have pent up demand and are ready to buy – if they can sell!
Remember, our market dropped 37.6% as a region since 2007 (some areas fell less than 20%, and other areas fell greater than 50%). The buyers with 20% down lost equity in their homes. Buyers with 5% or 10% lost substantial equity in their homes. If they sell today, they don’t have the down payment necessary for that next home.
Various predictions by “experts” suggest our recovery may be anywhere between 2% and 8% annually. At a conservative 4% annual rate of recovery, it is 5 more years before we can reach 20%. Those who last purchased their home between 2006 and 2008 are being hurt the hardest in today’s market.
One positive is that renters are ready to purchase. Generation X and Y buyers now believe in homeownership; they want to get out of renting apartments because rents continue to go higher than taking out a mortgage. Interest rates remain at historic lows, with no indication of a significant increase of rates on the horizon.
From the 3rd quarter to the 4th quarter, Chicagoland saw its first quarter to quarter increase in sales price since prices began falling five (5) years ago. All indications are that this trend is continuing. But the increase, although welcome news, is very small. (+0.13%). Many communities throughout Chicagoland are seeing more substantial increases, some are not yet seeing increasing values. (44%, or 84 out of 191 communities) saw increases over the past quarter.
Back to Supply and Demand …
A balanced supply of inventory is considered to be 4 to 6 months. A balanced supply is going to be neutral in pricing, while an undersupply is going to lead to upward pressure on prices – a Seller’s Market. An oversupply will lead to downward pressure on prices – a Buyer’s Market.
Our supply of inventory is at its lowest level since the end of 2006 and most areas have been reduced to a balanced supply of inventory, with undersupply observed in many sub-markets in the region.
Chicago Detached housing is 3.88 months, and Attached housing (condos, townhomes, Co-ops and duplexes) is 2.87 months supply!
The anticipation is that the pricing will continue to be pressured upward as the desirable properties (in terms of location and condition/modernization) will be gobbled up. Remember the multiple-contracts driving up values last decade? Many agents are now experiencing these trends again.
Get ready for a wild and crazy ride as our real estate market in Chicagoland is pulled and pushed in all directions in 2013
This could lead to things that do not make sense in the crazed market. Real Estate professionals (Agents and Appraisers alike) must take care to understand all of the nuances in the market signaling the positives taking place.
Just what we need: more complications to try to understand.
Here are a few things to watch…
- Watch the days on market (DOM). Take time to understand if an area’s high DOM may be due to stale listings of homes that are overpriced, distressed and/or in inferior condition.
- Trend the increasing Sales Price-to-List Price ratios – in many sub-markets that I appraise in, I have seen these trend from 93% to 96% or higher just in the past year.
- Track the number of pendings in relationship to the number of listings? One appraiser friend of mine tracks this and calls this “market velocity.” Right now, I see some areas where there have more pendings than listings in a given sub-market.
- Are the pendings priced higher than the previous sales prices? Another indication of an increasing market that I am seeing in many areas.
Welcome to, we all hope, the Housing Market Recovery!
By: Chip Wagner on the KCM Blog