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A Better Indicator of a Healthy Market: Liquidity

Today, we are again honored to have Ken H. Johnson, Ph.D. — Florida International University (FIU) and Editor of the Journal of Housing Research as our guest blogger. To view other research from FIU, visit http://realestate.fiu.edu/. – The KCM Crew

What is the definition of a healthy housing market?  Is it a housing market in which home prices are decreasing?  Few would agree with this.  Is it a market in which home prices are increasing?  At first glance, many would agree with this definition.  However, increasing prices cannot be used to diagnose a healthy housing market.  If increasing prices indicate market health, then in 2005 housing markets were “very” healthy, and we know that this is not true.

If pricing does not indicate market health, then what does?  The answer is simple: it is market liquidity and not pricing that indicates the health of a housing market.  Liquidity has been defined in many ways but it basically boils down to: can an individual seller, at a time of their choosing, successfully market their property at or near market value?  We often hear of rates (turn-over and absorption) that are related to this concept.  Unfortunately, these measures are difficult to estimate and they all have something to do with outstanding inventory.  What really matters, regardless of outstanding inventory, is the likelihood that a property will close.  This is the most basic meaning of market liquidity and it can easily be proxied.

All of the data necessary to proxy a particular market’s liquidity (and thereby its health) is available on the daily “hot sheets” of almost every MLS in country.  Since liquidity is really just a batting average all that needs to be done is total the successful transactions (closed properties) and divide these by the failed listing transactions (Expireds + Withdrawns + Cease Efforts + Cancelled)[1][2].  The resulting number is a very close approximate to the probability that any given property listed in that market will close and an increasing trend in this number indicates improving market health.

Implications

Pricing trends do not indicate the health of a housing market.  Keep in mind.  For almost every sell in an increasing market, there is a repurchase at a higher price.  For almost every sell in a decreasing market, there is a repurchase at a lower price.  Thus, pricing is a “double edged sword”.  Gains/Losses on a sell are almost always accompanied by higher/lower repurchases.  Thus, pricing trends can never indicate the health of a particular real estate market.  Instead, it is market liquidly, which can be easily proxied, that actually indicates market health.  After all, the real goal is for a seller of property to be able to transact at or near market value with a high degree of certainty.  Fortunately, most MLS’s around the country have the information at their fingertips to estimate the health of their particular market.

It is liquidity (not price) that matters.

Endnotes


[1] Different MLS’s have similar but not exact designations for these various categories.  The goal is simply to divide successes by failures.

[2] The timing of the calculation will depend on the number of outcomes each day on a particular market’s MLS hot sheet.  The goal is to avoid a mathematically undefined estimate.  Thus, larger markets might do this average daily, while smaller markets might only calculate this average on a monthly basis.  If interested, any MLS needing assistance in setting up this estimate may contact me.


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5 replies
  1. Pat McGinnis
    Pat McGinnis says:

    You mentioned that “for every sale in an increasing market there is a repurchase at a higher price and for every sale in a decreasing market there is a repurchase at a lower price”… one of the differences in our most recent market should be noted…. 25% to 40% of our transactions across the country have been distressed sales which usually doesn’t allow the sellers to repurchase either up or down.. most of these sellers have become tenants… I’m sure this has taken it’s toll on all “normal” statistics with a “move up” or a “move down” economy..
    Have you considered this in your projections???
    Seems like it’s a fantastic time to buy rentals…. low prices, low interest rates,and tenants being produced daily by the shortsales and foreclosures….

    Reply
  2. Nancy Farber
    Nancy Farber says:

    Interesting way to think about the market and will give me a new perspective on how to answer the age old question… “hows the real estate market”? Thank you.

    Reply
  3. Kurt Miller
    Kurt Miller says:

    One thing to keep in mind with this formula is the common occurrence of “Expired-Relisted” and “Withrawn-Relisted” properties. While MLS data will show that these listings have terminated, they never really left the market, and in many cases agents are attempting to manipulate the DOM (Days on Market) to “freshen” the listing and get back on agent hotsheets and customer auto-searches. As an MLS employee, we’ve always found tracking Inventory Accumulation and PMP (Property Marketing Period – The time a property has been on the market during a certain date range) to be better gauges of market health.

    Reply

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