“Months of Supply” is worst indicator of housing market activity
The “months of supply” indicator has little or no predictive power and often gives a false impression of the strength or weakness of the real estate market.
The “months of supply” is a measure of market absorption, providing a reading of how fast homes are selling relative to the supply of inventory currently available. For example, if a market has 50 homes available for sale and sells 10 of them, it would take 5 months to sell the remainder if no additional inventory came to market.
The “months of supply” is supposed to be indicative of how aggressive buyers are relative to sellers. In theory, a market with a low months of supply would have greater buyer demand than one with a higher months of supply. As an indicator it’s supposed to signal imminent price increases and thereby the best time to buy a house.
Unfortunately, as an indicator of housing market activity, it’s a dismal failure that often predicts rallies and busts that don’t materialize. The only real value the indicator provides is as a tool for realtors to manipulate buyers into action by frightening them with the fear of missing a bargain or being priced out. In that regard it has tremendous value to realtors — for buyers, not so much.
Predicting Busts and Rallies
For an indicator to be useful, at least occasionally, it must foreshadow some economic event. Months of supply is supposed to indicate busts and rallies, but its track record is dismal. From 1960 to 1982, house prices rose steadily, but the months of supply indicator predicted 5 busts, including two major ones that didn’t materialize. Then in 1982-1984 when house prices really did decline in California, the months of supply indicator was signalling a rally. The same happened from 1991-1994 when the months of supply also indicated a rally that corresponded to falling prices in California.
So this indicator falsely signaled eight busts and incorrectly signaled two rallies during the only two previous instances of house prices declining anywhere in the United States. How much more wrong can this indicator be?
From 1987 to 1990, California inflated an epic house price bubble, yet the months of supply remained consistently above 6.
From 1991 to 1997, house prices steadily declined in California, yet the months of supply fell below six and stayed there for most of the 1992 to 1997 period.
Quite honestly, based on the above analysis, it’s hard to see where realtors came up with the idea that the months of supply indicates anything. If we assume realtors always lie to generate false urgency with buyers (a reasonable assumption), then perhaps this was developed as a completely erroneous piece of propaganda during the previous busts in California. This is a reasonable explanation because in any price decline, buyers see little reason to buy, and they have no urgency. It’s easy to imagine realtors coming up with the 6-month supply rule because that’s all they had to work with. It’s hard to say for sure because the currently-accepted interpretation clearly does not come from looking at the data.
Over the last 16 years, the data has been a bit more predictive, but it doesn’t balance at six-months like realtors say but at five months based on data. The “six-month balance” meme is a distortion of fact (lie) promoted by realtors so often it’s become accepted as truth. It’s not. See the data for yourself below.
With few exceptions over the last 15 years, whenever the moths of supply has been below 5, prices appreciated. When it’s between 5 and 6, prices were flat, and when it’s above 6 prices fell sharply.
The next time you read a report that touts the strength of the market based on months of inventory, recognize the source is a realtor trying to manipulate you and treat it accordingly.