Friday, January 19, 2007

Real Estate - Months of Inventory and Price Changes

Okay, I just completed this analysis and I really wanted to get it out before the weekend. This is a chart based on Fraser Valley Real Estate Board statistics from January 2005 through December 2006 and it analyzes the link between Months of Inventory and Quarterly Price Changes. I would expect the exact same findings no matter which real estate market you look at.

What I discovered should come as no surprise to those who subscribe to basic supply / demand economic models. There is a strong inverse correlation to the number of Months of Inventory and Quarterly Price Changes (coefficient = -0.7911). Months of inventory is calculated by dividing the number of Active Listings by the number of Completed Sales in a month. Quarterly Price Changes are from the FVREB stats package.



My unoriginal hypothesis based on this observation and analysis is that when Months of Inventory rises above 6 then there will be negative price pressure. Based on what I am seeing in the market right now we are looking at 7+ Months of Inventory for January for the FVREB and the REBGV. This means that with a fair degree of certainty (4 times out of 5) we will see negative quarterly price change numbers.

And by popular demand, a chart tracking months of inventory vs. Monthly Price Changes with an inverse correllation coeffecient of -0.6664.

What will the numbers be for January? Any anecdotal evidence of anxious sellers and massive price drops?

23 comments:

Uncertain Buyer said...

Great Post. Hard to dispute a Graph.

Paul said...

great job. Very easy to understand and hard for bulls to refute!

kicker said...

Thanks for the chart. I sold my house a year ago and have been renting a place in Nanaimo.

We moved into our current rental in September, and within 2 blocks surrounding us there are 14 houses for sale. Some have been recycled on and off the market since I began watching the MLS in January 06. I have only noticed one sale so far.

Cecil said...

Great analysis. It would be interesting to see if this correlation held true during the previous market corrections in Vancouver.

Over at Rob Chipman's blog, he is of the opinion that that if prices are falling, sellers will hold on to their properties instead of getting a lesser price, which will drive inventory down, which will hold prices steady. I don't agree with this theory because the level of speculation in Vancouver is too high, with speculators being flippers *and* some owner-occupiers. Some may disagree that the latter group are speculators, but with the recent buzz over property assessments it appears real estate fever is at an all time high, along with ignorance of the underlying fundamentals.

Anonymous said...

Sweet chart, dude. Innovative analysis showing a strong correlation.

mohican said...

uncertain buyer - how do you feel about the months of inventory in the Okanagan now?

Uncertain Buyer said...

Feeling strong enough now not to be buying in the near future.

I am going to put my money, that I got from my house, into a GIC and wait awhile.

What do you think of going into a Mutual Fund?? The GIC is only around 3.5% and I can get my money out after 30 days. I will need access to my capital if I do decide to buy in the next year or two.

mohican said...

uncertain - if you have anything more than $100k get a Premium Money Market fund and that should yield 4% and its cashable anytime. Or ask your financial institution for a better rate. I have easy access to 30 day GICs at 4.1% and any discount broker or financial planner should have the same.

freako said...

First of all, good on your looking for relationships in all that data. I have been planning to mine Sauder's figures for some time, but I am too greedy. I want to chart more than two variables at the same time. Anyone have any suggestions how to do that?

As for the relationship, I don't think it is as strong and meaningful as it appears for the following reasons:

1. Seasonality: I don't necessarily think that the relationship between prices and listings (or demand and supply) is a cause and effect relationship. Rather, I think they both may result from seasonal factors. In the slow blah months, both sales and listings fall. In the brisk selling season, both rise. It is very possible that most price movements, simply happen in the busier times and they tread water the rest of the time.

2. As mentioned before, using a single months sales to calculate month of inventory can be misleading. The calculation is much more sensitive to changes in sales than changes in listings because listings are a cumulative number, and sales are not.

For example, assume that there are 10,000 listings, monthly sales are 2000 and monthly new listings are also 2000. There are 5 months of inventory. Then we hit the slow season, and both sales and new listings drop to 1000. The sales to listings ratio was unchanged, yet months of inventory doubled to 10 months. Clearly, the monhts of inventory artifically peaks in the slow season, more as a result of the nature of the calculation than changing market conditions. I mean, you don't judge Toy's R US October inventory build up on October's sales.

If look at the math, we will find that with 6 months inventory, listings will have to increase 6 times faster than sales, for months of inventory NOT to decrease. And that is without taking expirations into account.

In summary, seasonal sales variance, overstates months of inventory in the slower months.

I do think that this bubble has just about run its course, so inventory could still skyrocket. I think year over year changes in sales and inventory are the most telling. In either case, I applaud the effort, and eagerly await your next set.

freako said...

Oh, and I am curious as to what monthly price movements would look like. A quarter is of course three months, which means that two thirds of the data came from an earlier month. I presume that the monthly data is not handily available.

freako said...

"I needed thirty five percent down to get the loan, but the interest rate was 1.6%.
"

In that case, why bother with RE? Why not just plunk it into an ING account 4% for less risk? On the other hand, hardly risk free unless you believe interest rate parity has gone to greener pastures perpetually. Otherwise, currency fluctuations will level the playing field. Anyhow congratulations on successful flip.

mohican said...

freako said: "Oh, and I am curious as to what monthly price movements would look like. A quarter is of course three months, which means that two thirds of the data came from an earlier month. I presume that the monthly data is not handily available."

I posted the first chart (quarterly price changes) because I felt that the active listings would also be coming from previous months as well as the price changes. My feeling was correct because there was a tighter correlation there than the new chart representing the monthly price changes.

OnTheIsle said...

"Over at Rob Chipman's blog, he is of the opinion that that if prices are falling, sellers will hold on to their properties instead of getting a lesser price, which will drive inventory down, which will hold prices steady."

Agreed, that is bull. Wait til you are in the position that you have to sell cause of being transferred. I have been there in 1990 and the market turned on a dime from hot to cold within 2 months at this time of year too,that is why my gut is telling me this is the spring when the correction starts. Took me 4 months to sell in a nice neighborhood and a 20% haircut. The people that have to sell no matter what will be the catalyst to this overpriced madness.

freako said...

"I felt that the active listings would also be coming from previous months as well as the price changes. "

I am not sure I follow that. Monthly data points of quarterly price changes are essentially a moving average. There is a definitely a lag between offer acceptance and completed sale. You could always try a one month offset, charting October sales with September listings.

" My feeling was correct because there was a tighter correlation there than the new chart representing the monthly price changes. "

But isn't the variable that tracks apples to apples preferable to the one which correlates better? Shouldn't inventory need more smoothing (actually seasonal adjustment) than prices? BTW, not trying to pick the relationship you found apart, just trying to eliminate alternate explanations that come to mind. I think you are doing outstanding work finding and graphing these types of relationships.

Anyhow, the 12 month cycle is very obvious. Not sure, but suspect that looking further back in time would show more of the same.

I wonder what YOY change in inventory versus monthly change in price would look like. I have come to see the RE business a little like the flower business. The sales come at predictable times of the year. The key to price changes is the availability at these PARTICULAR times, not the rest of the year. To be able to determine what the underlying market is doing, we need to remove these seasonal effects. I learned that the hard way when I thought that fall inventory build up was a runaway train. The day may come when market forces overpower seasonal factors, but I don't think that is the case just yet.

So FVREB tracks inventory by month?

Kram99 said...

Last night, I attended an opening VIP night for an upcoming Maple Ridge development site. I have had this particular development on my radar for 6-8 months now and it was suppossed to begin selling this past August. Almost 6 months past their original plan and we decided to attend the VIP night to firstly see what the floor plans were like and of course to see what the prices were compared to the same developers prices this past August.

Prices were $50K more than what they were being advertised in August BUT the realtor began to offer incentives even after spending only 10 minutes with us. $10K off if you buy now was the start but we still decided to leave as the extra $50K price negated the extra commute we would have from living in Maple Ridge.

If the realtor of an upcoming development is willing to offer $10K within the first ten minutes then sales cannot be that great. End of story, I asked for $100K + window coverings and the door was shown to me. Perhaps, the window coverings was a little too much...

mohican said...

freako said: "not trying to pick the relationship you found apart, just trying to eliminate alternate explanations that come to mind."

Keep the thoughts coming, I value them highly. They allow me to hone the thinking and analysis.

freako said: "Anyhow, the 12 month cycle is very obvious. Not sure, but suspect that looking further back in time would show more of the same."

I agree that there is a significant seasonality here and I have not figured out a way to correct for it yet. Any ideas?

Kram99 said: "I asked for $100K + window coverings and the door was shown to me. Perhaps, the window coverings was a little too much..."

That is a good story. This is exactly the type of thing people should be doing so that we take some of the greed off the table in some of these newer developments. When they are sitting with dozens of units for sale and no buyers they will start to bargain.

freako said...

"Keep the thoughts coming, I value them highly. They allow me to hone the thinking and analysis."

Good to hear. Now I am convinced that you are approaching this from an objective point of view. Not that I had any doubts. I think we both are looking for what will happen, not what we want to happen.

"I agree that there is a significant seasonality here and I have not figured out a way to correct for it yet. Any ideas?"

Well, a couple of different approaches, but I think you need fit year over year in there somewhere. What is undoubtedly clear from your graph (which was not a secret) is that the majority of price movements come in the busy times. It would be interesting if that holds in neutral and bearish markets as well (will check Sauder on this). You are probably aware of the fact that stock market volatility is much lower during the really slow times (such as Chistmas). No doubt that is a result of the absence of the big movers and shakers. Think of it as a temporary truce of sorts. I now believe that RE behaves the same way. As, VHB suggests, I think we should be careful about reading into the data points during the lull.

What I am not as clear about is the impact of months of inventory. Without seasonally adjusting, I cannot confidentally conclude cause and effect.

Some thoughts (not deep):

Month to month price change versus absolute YOY inventory.

Month to month price change versus change in YOY inventory.

I also like the Bubble Tracking Blog's listings per population. Maybe that would be a good number to track.

These look at the supply side, what about demand? We can add YOY sales change to each of the above.

Another interesting question is whether a poor spring indicates a poor summer. In other words, if sales/price increases are poor and/or inventory is high in March, does that predict negative price pressure for the whole period? Or does is it more of a random walk?

I fear that the situation so abnormal and chaotic to draw any major conclusions. The market psychology of today is different that that of last year which is different than that the previous year. If, as I suspect, we have exhausted fundamental demand (borrowed from the future) and speculative demand can become supply on a dime, it is hanging by a thread. I think seasonally adjusted (ie. yoy) numbers for all the usual suspects (sales, inventory, new listings, prices) will tell us what is up as it happens. What about predictors BEFORE it happens? I think we all agree that inventory and sales will go before price. To predict when those move go, we need ESP as it is based on supply and demand, which are partly based on psychology.

It would be nice if there was a way of quantifying the end of the FTB market. How do we know when we are running out of borrowed demand? The ownership percentage is up a few percent, which of course means that there are fewer buyers left. If we are borrowing from the future, the average FTB age should be dropping. It would be nice to find some stats on that. As for the supply side, all we can do to predict supply is look at completions and anecdotally determine investor sentiment. I presume the MSM coverage gives a clue. I used to do a Google News search for "housing bubble", but I don't it was very reliable since many Wire stories get re-printed by locals.

In either case, we will know it when we see it. I presume that by the end of March, we should get a clear idea of how things stand. I don't think YOY price declines are out of the question by then. Sorry for cluttering your blog with a long rant on your blog, I will keep it short and sweet from now on.

freako said...

Ok, I lied. Just too curious, I did crank out quarterly price change data for the entire Sauder set. The null hypthesis is that most of the price gains occured in Q2 and Q3.

I didn't want to bother refreshing myself on statistics, so I merely calculated the average price change, followed by the average absolute price change (as a proxy for volatility).

Here are the results:
Average price change:
Q1 Q2 Q3 Q4
8.94% 8.81% 7.86% 7.65%

Average absolute price change:
Q1 Q2 Q3 Q4
13.16% 12.78% 10.87% 11.04%

Not what I expected. Average price change is almost a wash. Absolute price change peaks in Q1 and slows a bit in Q3. Maybe month by month would be more telling. And maybe calculating standard deviation directly instead of a lazy man's proxy would make a difference.

I also calculated how many times each quarter was the best performing for the 30 year data set.
Q1 Q2 Q3 Q4
7 5 5 13

That is more telling, Q4 (of all things by a long shot). Almost half the time it was top.

Next, how often each quarter was the worst performing:
Q1 Q2 Q3 Q4
12 4 4 10

Again, intersting. Contrary to what I expected, April through September was significantly underrepresented. When is peak sales volume?

Unknown said...

Mohican:

Nice chart, and excellent point about inventory levels. My numbers for REBGV have it at just over 6 months as of December 31, but that's up substantially for the mid 2s earlier in '06, and its been rising since July/August. That change is huge.

Cecil/ontheisle:

You're not quite right about what I think sellers will do with falling prices. I don't think falling prices will motivate a lot of discretionary sellers to sell. They will hurt non-discretionary sellers a lot. The number of non-discretionary sellers determines how far prices fall.


realtor88888888:

Are you saying the market crashed after Expo '86? The numbers indicate that the market actually rose for the following four years.

solipsist said...

freako - keep up the long rants. I, for one glean a lot from them. I just did a post mentioning the Ides of March - which is when I expect to see something happening.

The numbers over at RIREB look to be going into buyers' territory in the last week. But then, I see only what I want to see...

mohican - thanks for the graphs. My brain freezes when looking at aggregate numbers, and your, and VHB's graphs help put things in perspective.

freako said...

"Are you saying the market crashed after Expo '86? "

No, he is saying that people didn't think it could go down BEFORE 1986. It did. Badly. 1985 to 1987 were fairly flat, then things picked up between 1988 and 1991.

The present parallel is obviously the Olympic games.

Uncertain Buyer said...

Thanks for the input on the GIC's and accounts. I will try to put the screws to my Bank, BMO, and try to get more interest out of them.

mohican said...

Hey Freako, do you mind popping me an email? I have a question for you. Just use the email address at the top of the main page.