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Supply and Demand: How it applies to Real Estate

Supply and Demand. It is a relatively easy concept to understand. Most of us learn it in high school. The price of any item is determined by two variables: the demand for that item and the current supply of that item. If I had one of only seven Spanish gold coins known to exist, the coin would be worth a lot of money. If someone unearthed several cases of that same coin, the value of my coin would decrease dramatically. We can apply this principle to any item in the world – including real estate.

The price a buyer is willing to pay for a particular house will be determined by how many similar houses are for sale and how many buyers are currently interested in buying that type of home. That is the way real estate prices have always been determined. Back in 2005-2006, everyone wanted to purchase a home and there was limited inventory available. That drove up prices. The question is – where do we stand on supply and demand in the current real estate market.

Supply in real estate is measured by ‘month’s supply of inventory’. If there are 100 houses for sale and fifty sold last month, we would have a two month supply. If there are 100 houses for sale and ten sold last month, we would have a ten month supply. A normal market calls for 5-6 month’s supply. The chart below is a great guideline for house prices based on supply:

The last National Association of Realtors’ (NAR) Existing Home Sales Report showed there to be an 8+ month supply of homes. That report also quoted NAR’s chief economist Lawrence Yun as saying:

The upswing in April existing-home sales was expected because of the tax credit inducement, and no doubt there will be some temporary fallback in the months immediately after it expires.

Demand will ‘fallback’. And inventory is at levels higher than normal. The concept of supply and demand would dictate that prices will soften. And that does not take into account the ‘shadow inventory’ of homes experts predict is about to come to market. (In tomorrow’s blog, we will try to quantify that shadow inventory.)

What does this mean to you?

If demand weakens and supply increases, there will be downward pressure on prices. That will create tremendous opportunities for those who understand what is happening. Sit with your real estate expert to help decide whether this is the right time for you to make a move.

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