In my last post, I started our discussion on Understanding Pricing a house. The initial starting point is understanding the cyclical and seasonal nature of the real estate market. In this blog post, we are going to start drilling down. What are the price expectations? Are prices going up or down?
Let’s start with the concept of a buyer’s market vs. a seller’s market.
- A buyer’s market is when the supply of houses on the market exceeds the demand of buyers looking to purchase those houses. In a buyer’s market, you expect to pay a lower price for the same house as you would in a seller’s market. It also means that houses may sit on the market longer.
- A seller’s market is when the demand exceeds supply, which is when there are more buyers looking for houses than there are houses on the market. This leads to multiple buyers trying to buy the same house, which can lead to “bidding wars.” Buyers will likely see higher prices for the same house than they would in a buyer’s market. Homes also tend to sell faster.
The way to determine if it is a buyer’s market or a seller’s market is to look at the level of inventory on the market. If inventory is low, then it is most likely a seller’s market, and by low we usually say anything less than 6 months of supply.
For example, look at the months of supply of houses in Bethesda MD:
This chart shows the last 3 years. As you can see, the level of supply changes. The time period with the highest amount of supply is April 2016 at 4.3 months. All of these are less than 6 months and are a seller’s market.
(How do you calculate months of supply? Current number of homes on the market divided by the number of homes that are selling each month.) With high demand from buyers, and low supply, prices trend up.
Now let’s discuss absorption rate, which is the rate at which homes are being sold. (It is calculated by the number of sales per month by the total number of available homes. You may notice this is the inverse of the supply calculation.) The reason why absorption rate is so helpful is that it helps you to see trends in the market. Is the rate going up or down? If it is going up, then homes are selling faster.
Looking at the same Bethesda data, but for the last year only, you can see the absorption rate and the months of supply:
How do you use this info? Let’s say you are a seller and you want to put your house on the market in two months. You see that there are 5 months of supply of homes on the market and that the absorption rate is slowing, and has been slowing for a few months. That means that while it may be a seller’s market now, the market is slowing down and heading toward a buyer’s market. Your house may claim a higher price now than it will in 2 months.
Another important data point to look at is Days on Market (DOM), which is the number of days that houses are actively on the market (days active until under contract). Houses that sit on the market for a long time often sell for less than houses that sell quickly. A low number of days on market is an indication of a seller’s market. We will talk about pricing strategies later, but one reason why real estate agents typically do not want their sellers to list their house too high above what they expect the market will bear is that these houses tend to sit longer. Once they do they get less than they would have, had they priced their house at the expected market value when they listed.
Compare median and average days on market for Bethesda and Dupont/Adams Morgan: