In this episode of the REconomy podcast from First American, Chief Economist Mark Fleming and Deputy Chief Economist Odeta Kushi examine the housing market’s supply shortage ahead of the spring home-buying season and explain how the annual pace of home sales can be rising when there are so few homes for sale.

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“The demographics of millennial demand and these low interest rates, even though they're a little bit higher than a month ago, they're still low. That demand is going to remain, so the supply and demand dynamic is unchanged. No near term, perceived flow of additional supply. And I just don't think there's going to be much inventory relief, and the velocity will remain high in the market this spring.” – Mark Fleming, chief economist at First American

Transcript

Odeta Kushi: Hello, and welcome back to another episode of the REconomy podcast where we discuss economic issues that impact real estate, housing and affordability. I'm Odeta Kushi, deputy chief economist at First American and here with me is Mark Fleming, chief economist at First American. Hi, Mark.

Mark Fleming: Hey Odeta. How are you? It's a beautiful spring day, we're going to talk about the spring home buying market. I'm so excited about this one.

Odeta Kushi: It does really feel like a spring day today, doesn't it? And we do indeed have an exciting show for you today. A relevant and timely one, I think. So these days, when you hear the term home buying, you might automatically think shortage. And that's because the housing market these days is notorious for a lack of supply relative to demand. And this isn't new. The housing market has been under built for the last decade. Although recently the problem has become more acute. To throw some stats your way, in January, months’ supply, as reported by the National Association of Realtors was 1.9 months and housing inventory sunk to a historic low of 1.04 million. What does that mean? That means that at the current sales pace, it would take just 1.9 months for housing inventory to be depleted. Compare that to three months, just one year ago. So we are indeed in an inventory crunch. And yet, the latest existing home sales report indicates a seasonally adjusted annualized rate of 6.7, million homes more than 20% higher than one year ago. So, how is it that you can buy what's not for sale? And to answer this question, I think we first have to understand how we measure inventory. And that's where Mark comes in.

Mark Fleming: I don't get it. You're absolutely right. How can we have so many home sales, if there's nothing to buy? This is an incongruous statement that we have to make here. And it really does get down to the definitions of the data. Home sales are easy, we can track how many people have bought or sold a home. That's an easy number. We're all well aware of that. But the calculation of inventory is quite interesting. The inventory is measured at a point in time and in a given month only at one point in time in that given month. And it's what we refer to as a stock measure, it's the stock of homes for sale at that snapshot of time. But the for-sale housing market is a flow, we're counting the flow of how many sales every month. So, there's this fundamental difference between a stock measure and a flow measure. Now this gets really complicated, you say wait a second, what's going on. We have to talk about bathtubs and imagine a situation where I'm trying to fill up a bathtub with water, but the drain is open. And the faucet is on. Think of the faucet being on is the flow of sales into the bathtub. And the drain at the bottom is the sales that have been closed and are sort of going out the other side. And at any point in time, the amount of water left in the bathtub is your inventory. And so what happens in the housing market is we've got the spigot open at the top, we've got the drain open the bottom. And once a month, we measure how much water is in the bathtub. Now, keeping this analogy going, the less open the drain is at the bottom, the more flow in the top, the more inventory or water is left in the tub at that measurement point. Turn it the other way around, if the flow in the top is slower, but the drain is wide open, the level goes down and there's less inventory. And so, these are the dynamics at play. The inventory measure, as its measured today, only measures at one point in time. But, what's missing is a whole pile of water might have come into the bathtub and out the drain before you even knew it. And so there we look at measures like days on market, how fast or what is the velocity of markets. And what's happening today in our market is the average days on market is 21 days, a lot of homes are flowing into the top of the bathtub and flowing out the other side before we even get a chance to measure them as part of the inventory.

Odeta Kushi: Alright, so it looks like we don't account for the volume of water that flows through during the month. So that might be home sales that closed for example. And I would like to think of it in in terms that I understand, so right I am a potential home buyer in Washington DC looking at these inventory numbers, looking at how many homes are being sold. So, let's say that in my home market of Washington DC, two homes are listed for sale. One was listed on January 2, and the other was listed on February 2. If the homes are both on the market for 60 days, then that inventory level on February 28 would be two right. However, if the homes each sold in 30 days the inventory count at the end of February would be one, but the number of home sales would still be two. So I think that gets to your point, Mark, where a higher velocity of sales or a lower days on market helps to explain a housing market that's characterized by both higher sales and lower inventory. And by the way, one of the things that's really helped us along, and we talked about this a little bit in the last podcast, is all of the technological innovation that's allowed homes to sell much quicker, right? We have better search tools, you know, and just a more streamlined process. And so it's allowed for us to have this higher velocity of sales. But what this really gets down to is, it seems like we're asking the question of, how low can inventory go without impacting sales volumes? So how fast can homes sell?

Mark Fleming: You know, I love the 1980s. So, we got to go back to the 1980s and the 1990s. And if you recall, the old conventional wisdom, well, actually, you don't recall because you’re too young to recall the 80s and 90s. But, in those days, we used to say, well, it would take 90 days to sell your home, that's an implicit days on market of 90 days. Well, if I'm measuring the amount of inventory in that proverbial bathtub every 30 days, and it takes on average, 90 days, we don't even have this problem. It just doesn't exist, right. But, as you say, technological innovation, more ability to find homes for sale, like the all of the things that are making those matching markets, like we talked about in our last podcast, making those matching markets more efficient, is creating the ability or the velocity of the market to actually increase. We use a term in manufacturing, they use the term “just in time supply.” Well, our stodgy old housing market seems to be moving more towards this just in time supply style of marketplace, because the matching process is that much more efficient due to technological innovation. So, the question then becomes, how low can you go, as you ask? Well, it's probably going to be governed, at least by how long it takes people to go back and forth and negotiate a contract. So what, five, maybe 10 days seems to be a reasonable floor. But the bigger question then becomes, maybe what we're seeing in the low traditional measure of inventory is a combination of two things, not just the current supply and demand dynamic, but almost a paradigm shift in what's considered normal from an inventory level. Because if we're moving to a ‘just-in-time’ supply-style market, even in a balanced supply and demand market, we might expect to see less inventory in the bathtub at the end of any given month.

Odeta Kushi: That's a really good point. And I'm not going to let you make an 80s/90s comment without making a comment back. And that is, I think, speaking on behalf of the millennial generation, 90 days on market is unheard of. I mean, I just can't fathom being in a housing market where that's the case. I'm quite used to this whole 21 days on market scenario. But you know, what you just mentioned really kind of begs the question, we might be in this new normal. So ,what's potentially a better way to measure inventory, if not, at the end of the month, the stock measurement that we were just discussing, what's a better way to capture inventory?

Mark Fleming: We have to recognize, first of all, that there are two different types of measures, the stock and the flow, and be conscious of mixing them. And I think we've basically established that the stock measure of inventory, as we do it today is insufficient. Because you could have an unchanging stock measure of inventory and very low flow, very low velocity. And it's the same exact measure of inventory and very high velocity, you just wouldn't know the difference by looking at the stock inventory flow. So it has to be at least a combination of things, all at the same time. Healthy markets may not necessarily be simply characterized by a stock measure of inventory, but also by that dynamic of velocity. So, the better way to measure it is to not look at just one number, but really understand the dynamics of all of these numbers as they interact effectively in that bathtub analogy.

Odeta Kushi: Right. So we've explained how it's possible to have historically low inventory with historically high home sales. Let's finish up by explaining what we expect going forward for both supply for demand and then of course for market velocity. And then you mentioned a potential velocity floor. You said you know, how long does it really take for a home to be sold. So, what happens when we reach that floor? Are we going to run out of homes for sale?

Mark Fleming: If we knew what the floor was, we might be able to figure out if we would run out of homes for sale. But I presume, yes, I mean, if the if there's so little left in the bathtub, that floor, that's actually really just perfect just-in-time supply. So, you wouldn't run out of homes for sale, it would just be that a home is never sitting on the market, it's being delivered. It's being found. It's being bought, and we move on to the next one. So, you can have high velocity and be at the inventory floor with basically the amount of water flowing in and the amount of water flowing out being exactly the same. I think the bigger issue though is in the long run, do we expect that there will be this surge of excess extra supply, you know, will more flow in from the top into that bathtub? Well, we know that home builders are building as fast and furiously as they can, but it's just not going to be enough. Home building and new home sales only represent about 10% of the total market. The other 90% of the market is represented by existing home sellers. And those existing home sellers, well, they're looking at it from the perspective of one, I might be able to lock in a 3% or below 3% mortgage rate right now. So that's creating one disincentive not to bother to sell your home for sale. But, more importantly, almost all of those home sellers are also going to become homebuyers. As soon as they sell their home and put yourself in the homebuyer shoes, you're saying, well, I don't know that I want to sell because I'm afraid I won't be able to find something to buy because the velocity is so fast. So, I don't expect to see the traditional surge in inventory like we've seen in years past in the spring home buying season. And, you know best Odeta, that the demographics of millennial demand and these low interest rates, even though they're a little bit higher than a month ago, they're still low. That demand is going to remain, so the supply and demand dynamic is unchanged. No near term, perceived flow of additional supply. And I just don't think there's going to be much inventory relief, and the velocity will remain high in the market this spring.

Odeta Kushi: Well, you made a lot of good points there. Everything from this existing owner rate lock, in effect, to the inability for existing owners to find something better to buy to incentivize them to leave that home. So we're in for a continuation of this supply crunch. But, given the explanations today, it seems you can buy something seemingly not for sale. But, this spring, buyers will have to move very fast to keep up with market velocity. Thank you very much for joining us on this episode of the REconomy podcast. Be sure to subscribe on Apple, Google, Spotify or your favorite podcast platform. You can also sign up for our blog at www.FirstAm.com/economics. And if you can't wait for the next episode, you can follow us on Twitter. It's @OdetaKushi for me and @MFlemingEcon or Mark. Thanks and until next time.