A brief history of local real estate, part 4: inventory.

A brief history of local real estate, part 4: inventory.

In our ongoing but brief—very brief—survey of local real estate trends since early 2000, part 1 dealt with home prices, part 2 examined absorption and part 3 looked at sales. This week, class, we'll see what inventory levels can tell us about the recent state of local real estate.

Inventory is one of real estate's more straightforward indicators—which isn't saying much. It's widely believed that there's a negative correlation between inventory and price: that is, if the inventory of homes rises, the price of those homes must flatten or even decline. That's held to be true both of real estate's long-term cycles—periods of boom and bust over years—as well as its seasonal cycles (spring boom, summer doldrums, fall rebound, winter hiatus). Yet, oddly enough, prices reach their seasonal low when inventory does, in the dead of winter. Is this positive correlation between inventory and price just an annoying anomaly, or can it occur at other times of year, or even over one or more years? We'll see.

Here's historical levels of inventory for five local sub-markets since April 2000.

Aside from showing how significant inventory's seasonal fluctuations can be, the chart reveals some other quirks about this indicator.

First, note that real estate inventory can be at its lowest when demand for real estate is highest—check out those depressed inventory levels during one of this area's hottest real estate markets, the last glorious days of the dot-com bubble. Ever heard real estate called an "imperfect market"? Chances are that this is what they were talking about. In other markets, rising demand persuades producers to ramp up inventory; low inventory, on the other hand, indicates that producers are unwilling to bring product to market because depressed demand is driving down prices. But as I've said elsewhere, ramping up housing inventory is, at least in this area, a challenging, uncertain and lengthy process.

Of course, the obvious answer to low housing supply during periods of high demand is that most "product" sells, and quickly. "A rolling stone gathers no moss" etc. But this still only partially answers the question, "Why does real estate inventory get scarce just as everyone gets real estate religion?" After all, there are still plenty of existing homes to sell. Why don't more local homeowners cash in on a seller's market?

I don't think anyone knows the answer, although I've heard some good guesses. For starters, there's this answer/question: where would those opportunistic sellers go after they sold? They already live in one of the most desirable places on Earth. Where would they move to, unless it's to their Final Reward?

Here's another theory: we know that much of the demand for housing comes from move-up buyers. Sure, a seller's market means they can sell quickly and for top dollar, but if the good times are distributed evenly throughout real estate's price ranges, those sellers/move-up buyers will have to compete for their move-up homes and pay a premium to get them, if they get them. Not only that, Prop 13 usually boosts the property taxes on their new home astronomically. Last but not least, move-up buyers face the possibility of a huge capital gains tax—in this area, the federal $250k/500k exclusion doesn't go all that far. Even in this market, one that gets increasingly softer as you go up the price range, move-up buyers still face these challenges to some extent.

Something else the chart reveals is the remarkable increase in low-end SFR inventory from early 2005 to late 2008—and, equally remarkable, the fact that low-end SFR inventory is now down to late 2005 levels, just as bargain-basement prices and rock-bottom interest rates whip that end of the market into a buying frenzy. Can anyone look at this chart and a) doubt that banks have learned to manage their ever-swelling REO inventory, and b) wonder why buying an affordable SFR is so competitive these days?

Finally, let's see whether the truism that inventory and price always negatively correlate stands up to analysis. In other words, do home prices always go down when inventory goes up, and vice versa?

To answer this, first let's look at the interplay between these two factors at the local low-end SFR market. Inventory levels are on the left of the chart, average sales price per square foot on the right.

Sure enough, there's a strong negative correlation—mostly. Prices decline in mid 2007 just as inventory explodes. Of course, there's also that pesky "anomaly" from early 2005 to late 2006, when prices rise along with inventory. The explanation? Maybe we're seeing what risky lending and lots of it did to low-end SFR, local poster child for risky lending. Easy credit (and then some) kept pouring buyers into that end of the market, just as strapped and disenchanted homeowners were beginning to bail.

Those are the facts, but is it really the explanation?

Next let's look at local midrange SFR during the same period.

Now the pattern's a little different. There's a negative correlation between inventory and price until early 2004, but then it shifts to positive—and in a part of the market that saw relatively little risky lending during that period and is still fairly robust, more than four years after the great "real estate bust". And just to confuse things a bit more, both inventory and price have trended downward since mid 2008.

Feel up to one final chart? Sure you do. Here's top-end SFR.

We see another inexplicable rise in both price and inventory, from early 2004 through 2005. Then there's a more intuitively-predictable surge in price as inventory dips, but at a time when real estate values were supposedly in a death spiral. In fact, it wasn't until summer 2008, typically a slow time of year in this price range as buyers spend their obligatory month in Italy, that top-end SFR faltered. And it took the very atypical financial meltdown of late 2008 to stop this market dead in its tracks.

So as I said, inventory is one of real estate's more straightforward market indicators. And as I also said, that's sure not saying much.

In two weeks, A brief history of local real estate, part 5: days on market.