Downturn or Market Shift?

Home prices in the U.S. have increased for 52 straight months according to data provider Core Logic. In fact, Colorado home prices continue to set record highs. The real estate market is strong, but are we starting to see signs of a shift in the market? Or even worse, a downturn or an impending crash as some prognosticate?  We will take a closer look at these possible scenarios this month, but first the market stats.

graph1 for downturn or market shiftOverall, the market struggled a bit in July to match the activity levels of last year. The volume of real estate sold across all Front Range markets in July decreased 4.5% on a year-over-year basis. A wave of new listings caused inventory levels to increase slightly to 1.7 months. A larger selection of homes, even if ever so slight, is a welcome sight for fatigued buyers.

July was the second consecutive decrease in year-over-year sales volume. Clearly, the market is struggling with the same problem that has been the primary impediment going on three years now – too few homes for sale for the number of buyers.

The good news is that we did see a wave of new listings come on the market in July. This new supply should take some of the friction out of the market, allowing more buyers to close rather than just shop. Don’t be surprised to see an uptick in market activity in August and September as the listings that hit the market in July close.

So there appears to be a potential shift to a more balanced market. When inventory levels reach the 5 -7 month range, buyers gain more negotiating power, and appreciation rates become more moderate at 4 or 5%. We’re already seeing signs of this shift at higher price points and in areas that are further out geographically and have to compete with new construction. That said, it would be a mistake to confuse a shift in the market with a downturn or a crash like we saw in 2006. The conditions that would cause a downturn simply do not exist right now.

Folks who are currently predicting a downturn lack the data to support their hypothesis. Most often, the argument is “what goes up, must come down.” Historically, that hasn’t been the case with real estate. A more accurate assessment would be “what goes up will level off for a few years before going up again.” We certainly may see that leveling off in prices in the coming years.

Another mistake people make in analyzing real estate markets is taking a short-term view and getting caught up in the “noise” of passing events. Real estate markets follow predictable seasonal patterns and overall move much slower than equity markets.

graph2 for downturn or market shiftA single data point, in particular one based on a month-over-month comparison, certainly does not signify a trend. A headline in a major newspaper recently proclaimed, “home prices are down.” Their conclusion was based on data that showed the median home price fell from June to July. Never mind the fact that the median price had fallen every year from June to July for the last 4 years, indicating a seasonal pattern. On a year-over-year basis, all the major home price tracking indices show appreciation of 6% or more.

Of course, the real estate market, like any market, is not immune from a correction. The biggest threat to the market is an increase in interest rates that would significantly reduce affordability and ultimately take a significant number of buyers out of the market. However, rates are so low right now, that an increase of a percent or two would likely be absorbed by the market. Some buyers might actually decide to move a bit quicker to avoid higher rates. For now, the market fundamentals of high demand (due to low interest rates, in-migration and job growth) and limited supply are the reality on the ground. Personally, with the uptick in supply, I’m happy to be able to put more buyers and sellers together.

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