A brief history of local real estate, part 3: sales.
In part 1 we looked at trends in local home prices since the dawn of time, or since early 2000, which is sometimes the same thing here in Silicon Valley. In part 2 we examined trends in absorption, a market indicator that may sound esoteric but is in fact the most informative and predictive of indicators.
This week we'll check out trends in sales, the market indicator widely considered the best and perhaps only signal of real estate's strength, yet arguably the least important and most misleading of its indicators.
Why the widespread confusion? Because sales is one of those aspects of real estate that the average person intuitively understands, but only incorrectlyand, trust me, plenty of online real estate commentators have built reputations by going solely with their gut. Besides, it just makes sense: if sales are down, real estate must be down for the count. And if sales are up, real estate must be up up up!
It just makes sense. If BMWs are hot, more people buy BMWs and are willing to pay a premium for them. If BMWs are not, fewer people do and they aren't. So if real estate is hot, more people buy real estate and are willing to pay a premium for it. If real estate is not, fewer people do and they aren't.
The problem with this gut-level grasp of real estate reality is that it's a lot easier to ramp up Beemer production than it is to ramp up housing production, especially in this area, where land is scarce, politically powerful NIMBYs are not, and planning departments rule with an iron hand. New condo developments take several years to come to fruition, face microscopic scrutiny from government and individual citizens and, if the neighbors have anything to say about it, those developments end up substantially smaller than the developers planned. What about large new single-family developments? I hear the Central Valley has a few.
Armed with this perspective, let's look at recent sales trends in the five most prominent local sub-markets:
First, of course, it's apparent that sales aren't just highly cyclical, they're highly seasonal. Sales typically spike in late spring, then plummet in early winter. So the smart buyer buys when sales are down, right? Yes, if the smart buyer doesn't mind picking through a limited selection of homes, because one reason sales slump when the temperature drops is that many unsold homes are pulled off the market without being replaced with new inventory. Sellers take their summer recess in the winter.
Let's see if local real estate obeys the truism of "high sales, high prices". For simplicity we'll track just one sub-market, midrange SFR, because its greater sales volume will give us the most accurate picture. And also for greater accuracy, we'll use sales price per sq.ft. rather than average sales price, because the latter can vary significantly from month to month due to significant variations in average home size sold each month.
Take away the seasonal variations, and you can see a strong correlationboth positive and negative. Both sales and prices drop as dot-com busts in 2001, surge briefly in early 2002, flatten during the mass-anxiety inducing ramp-up to Iraq, then rise through 2004. Just what you'd intuitively expect: a positive correlation between sales and prices. But note that prices spike in early 2005, even as sales drop sharply, a trend that continues for two years, through 2007. Prices keep climbing well past 2001 levels even as sales sink well below 2001 levels. And don't be too quick to blame or credit risky lending for this "anomaly", because midrange SFR was one sub-market that saw very little of it.
So the next time the media breathlessly reports home sales downor upas if it meant anything more than that, don't assume that real estate prices are on the rocksor on the rise.
In two weeks, part 4: inventory.