How does the law of supply and demand relate to real estate? How can you use supply and demand to educate your buyers and sellers?
All economies are driven by the law of supply and demand. Simply put, supply and demand is the most fundamental concept of economics, and it’s the backbone of the market economy.
Demand, of course, refers to how much of a product or service is desired by buyers. Quantity demand is the amount of product people are willing to buy at a certain price. Supply represents how much the market can offer, and the quantity supply refers to the amount of a certain good that producers are willing to supply when receiving a certain price. Price, therefore, is a reflection of supply and demand.
In the housing market, it’s considered a level market when there is between a five- to six-month supply of homes available. If there’s less than a five-month supply, it’s considered a seller’s market. If the supply is greater than six months, the market favors buyers. Buyer and seller markets, then, vary drastically depending on how much inventory is available.
To calculate the absorption rate (or months’ supply of homes) of our housing market, you take the total number of active listings and homes under contract and divide that number by how many homes have sold in the last 30 days. This absorption rate indicates how long it would take to sell off all available inventory if no new homes came on the market.
The absorption rate helps us Realtors educate buyers and sellers. It’s also very helpful in forecasting where the market is moving. For example, if you have many more properties under contract than those that have come on the market in the past 30 days, that means the market is moving deeper into a seller’s market. Absorption rates can apply to a city, zip code, or a single neighborhood.
This statistic is also useful for bracketing price ranges in specific zip codes. For example, let’s use the market snapshot of Draper, Utah during May 2018. Draper had a 6.5-month supply of single-family homes at that time, which looks like a slight buyer’s market. If you broke it down by price range, though, you’d see that there were only 14 single-family homes that were active, under contract, or backed up below $400,000. In the previous 30 days, 11 of those homes had sold. This shows us that Draper had just a one-month supply of single-family homes under $400,000.
On the other hand, there were 154 single-family homes above $500,000, and only 21 had sold in the past 30 days, which means there was over a seven-month supply in that price range. It was like a tale of two markets—very little entry-level product, but plenty of product as you move up in price range.
I generally find that you can price a home ahead of the market if the supply is less than three months. The higher the months’ supply of homes above the six-month mark, though, the more aggressive you have to be. In that situation, sellers might also have to go the extra mile to help their homes stand out among the competition. Likewise, buyers will have more room to negotiate in that scenario.
We hope this helps you understand the power of supply and demand. As always, if you have any questions about this or any other real estate topic, don’t hesitate to reach out to us. We’d love to speak with you.