Low inventory cycle

Recent data show that the number of homes for sale in the United States is at its lowest level since before the global recession hit. The “inventory” of unsold homes on the market, has been estimated by the National Association of Realtors to be around a 4.6-month supply, meaning at the current rate of sales, it would take 4.6 months to sell them.

Now, what the NAR considers a “healthy” inventory of homes on the market is a six-month supply. You don’t have to be a genius to figure out, then, that what’s going on now would be called “unhealthy.”

And the reasons for it are numerous, and you can blame this or that – slow new home construction, underwater loans, etc. – for what have become seller’s markets in many cities across the country. But what’s not debatable is that as good as the words “seller’s market” sound to someone thinking of selling their home, the truth is that a heavily leaning market – buyer or seller – is usually not healthy for anybody.

And once inventory is low, it tends to stay low for a while. The cycle of low inventory can be quite a circular one.

Think about what’s necessary for a market’s inventory of homes to grow to, and stay at, a healthy level. Sellers. If you want homes on the market, people have to be willing to sell.

And as equity returned to homeowners after the foreclosure fallout, there seemed to be more willing sellers. People who were waiting until they could get out from underwater on loans, finally put their homes up for sale when they could. The thing is, when someone sells a home, they now need somewhere new to live.

And guess what? In an area where inventory is low, their options are fewer. The bidding war that they might have enjoyed as sellers isn’t quite a fun when you’re on the other side. And make no mistake, there are people who would like to sell their home but are not doing so, simply because they are worried about finding their next home. If you’re not willing to change markets, you’re at the mercy of the market conditions.

So what happens? Faced with the prospect of running into problems finding their next home, people sit tight. They wait. They don’t put their house on the market. And what that does is, obviously, keep even fewer homes off the market, keeping inventory continually low.

And this isn’t a problem everywhere. Sure, it’s very apparent in Silicon Valley or Phoenix, or Denver, where inventory is so tight that people who might want to sell a home can’t afford the “move-up” that many households make. I’ve written this before, but if you want to know the real reason behind first-time buyers’ number being low, it’s got a good deal to do with the people living in starter homes not being willing to sell to first-timers because they can’t touch the type of house that’s a step up.

If you bought a house for $100,000 in an area that has since taken off, maybe it’s worth $300,000 now. That means the $200,000 house that you’d normally consider moving up to is now selling for around $600,000. Even with $200,000 in equity to put down on the new home, you’re talking about having to qualify for a $400,000 mortgage. You have to earn a decent living to qualify for that amount.

And when giving the choice between making a lateral move – a new home but not a step up – or staying in the home you’re already in, well, what would you do? Exactly. Which is why areas with low inventory typically languish in low-inventory limbo for quite some time.

But markets do break out of the cycle eventually. Sales volume goes down as pent-up demand is fed, and that, in turn, means home prices that don’t rise as rapidly as they have been in some areas. For as much credence is given to first-time buyers, real estate is really more a trickle-down thing. As the top levels reach unaffordable levels, it’s the resulting lack of inventory that makes the next level down less available and, therefore, more pricey.

So while it might sound nice to sellers that they’re in sellers’ market, the reality is that you quickly turn buyer most of the time. And then you’re caught in the low-inventory cycle, which in the long run, isn’t good for anybody.