Price Changes, Sales and Inventory

A recent foray of activity in recent business news feeds has uncovered a slightly revised outlook on Canadian housing from investment shop PIMCO. Articles can be traced through Luke Kawa's article. What it seems to have boiled down to is an expectation that national prices could fall -20% to -10% in real terms (I'm assuming a 2% inflation rate) over about five years, though this could possibly happen faster. Taking the view that such a correction is going to occur over five years we can infer what this will mean for sales and inventory.

In Vancouver, sales and inventory have a relationship to price changes. Here is a graph showing annualized price changes versus the ratio of for-sale inventory to monthly sales (months of inventory AKA MOI) since 2005:

The relationship between MOI and price changes is clear however the variance is substantial. Using a baseline assumption of MOI of 7 leading to flat nominal prices and an MOI of 10 leading to -5% nominal annualized price changes, we can determine what level of increased inventory and decrease in sales is required to elicit the price drops conducive to PIMCO's -20% to -10% real call. (This is not to say that Vancouver will be in-line with the national average but the analysis is here as an example.) I have colour coded the results. Results are based on changes from current sales and inventory levels (that are around MOI=6.5).

MOI resultant from changes in sales and inventory from current levels:

Nominal annualized price changes based on inventory and sales changes

Real price changes over five years based on inventory and sales changes

The above charts are concentrating on the scenarios discussed by PIMCO. This is not to suggest that their estimates are realistic; price increases are certainly possible but not considered in the charts.

We can use the charts as follows:

To get a -10% real drop over five years, that would require:

• an average increase in inventory of 10% with a 0% change in average sales
• an average increase in inventory of 5% with a 5% change in average sales
• an average increase in inventory of 0% with a -10% change in average sales

To get a -20% real drop over five years, that would require:

• an average increase in inventory of 30% with a 0% change in average sales
• an average increase in inventory of 15% with a -10% change in average sales
• an average increase in inventory of 0% with a -25% change in average sales

An interesting observation is how little sales and inventory need to move (inventory up 15% and sales down 10%, say, albeit for a prolonged five year duration)  to change a slightly-increasing market (the current scenario) to one that will be down -20% in five years.