One housing market indicator you should never trust
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.
Realtors invented the “months of supply” to measure market absorption, providing a reading of how fast homes sell relative to the supply of inventory available. For example, if sellers list 50 homes for sale and if 10 of them sell, it would take 5 months to sell the remainder if no additional inventory came to market.
The “months of supply” ostensibly reveals the aggressiveness of buyers relative to sellers. In theory, a market with a low months-of-supply exhibits 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. In reality, it’s merely a tool realtors employ to generate false urgency among buyers.
Predicting Busts and Rallies
A useful indicator would, at least occasionally, foreshadow some economic event. Months-of-supply signals numerous 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 signaling 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. Based on past performance, months-of-supply excels as a contrarian indicator that signals exactly the opposite of what realtors claim.
It gets worse.
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 realtors conceived months-of-supply as a completely erroneous piece of propaganda during the previous busts in California. Realtors needed a tool to generate urgency because in any price decline, buyers feel no urgency. A little bullshit goes a long way. Realtors probably invented the 6-month supply rule because they needed something, anything, to work with. The currently accepted interpretation clearly does not come from looking at the data in California.
Over the last 16 years, the national 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 dipped below 5, prices appreciated. When it hovered between 5 and 6, prices flattened, and when it rose 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 indicator is useless and treat it accordingly.