Real Estate Market Indicators: What do you need to know?
Market Indicators
Making Sense of Numbers
Perception is reality. There is absolutely no getting around that, especially when it comes to value. Value is essentially how much we think something is worth. We can have independent appraisers look at numbers and tell us what something is objectively worth, but if no one is willing to pay that amount, is it really worth that much? Thus, we determine that value truly is a matter of perception.
However, we’re not bound by the whims of one individual’s perception. No, when competing against like-items in the marketplace, supply and demand drive those items to trade at their market value. And how do you arrive at market value? You look at market indicators.
In real estate, there are a few market indicators that will help you determine what the current market is like. Depending on which side of the market you’re on, buying or selling, these indicators can help you make decisions on how you should respond.
What is DOM?
The first market indicator we’ll take a look at is the average number of days on market, abbreviated DOM. This figure is especially helpful in determining the speed of the market.
You arrive at DOM by first looking at the number of home sales within a given market. The amount of time between those homes being listed for sale and going under contract are the days on market for those homes. Add the days on market for each home together, then divide by the total number of homes sold, and you arrive at average days on market, or DOM.
The national average for DOM is 65.
That’s the number for our entire nation, so it’s important to remember that a market is defined by whatever boundaries you apply to it. A city has a housing market, and so does a neighborhood.
Fewer DOM indicates a hot housing market, and longer DOM would indicate a slower market.
What should buyers know about Days on Market?
As a buyer, you should look at this indicator in order to determine how aggressive you should be. If you’re looking in a neighborhood in which homes usually sell within 15 days, you really need to have your affairs in order and make sure you make time to see a house as soon as it crosses your radar. If you’re only making time to see houses on the weekend, then taking 2-3 days to discuss financing options with your lender, you’ll probably find yourself hunting for longer than you expected. There is nothing wrong with that. Just be prepared to miss out on a few great buys.
On the other hand, in a market where homes are typically listed for sale for 120 days or more, maybe you do have time to schedule a second visit, bring a contractor through the house, or let your kids see the place before you make your offer.
How should sellers respond to Days on Market?
Sellers can use this market indicator to inform a few decisions.
First, let’s talk about how DOM can help you determine when to list your home for sale.
Every hot-market seller I know is concerned about becoming homeless. When the getting is good and you know you’re not pushing the envelope on pricing, you can look at short DOM to determine that the home probably won’t be listed for sale for very long. Maybe you do wait to put it on the market until you can find your next home. However, if you’re trying to get into another hot market, you probably won’t be very competitive if you have to sell a home that isn’t listed in order to buy the next one. Talk to your real estate advisor about the dynamics in each market in order to make your plan of attack.
Now, let’s discuss where to list your home for sale, or, at what price.
Few DOM means that there are likely more buyers in the marketplace than there are homes for sale. This is what we mean by a seller’s market. Congratulations! You have a home to sell in a hot market! When demand exceeds supply, prices generally rise, so take this indicator as an opportunity to raise the price ceiling of the neighborhood. You might be surprised what the neighborhood will support.
Sellers also need to be receptive to extended days on market. If you find yourself doubling the DOM you expected, take the opportunity to reevaluate. You might need to make yourself more accessible to showings, address the condition of the home, and/or reassess your pricing versus the competition.
Understand that buyers are aware of the home being on the market longer than normal. Questions start being asked. Is this house overpriced? Is there a problem that other people are seeing? What am I missing, because something is telling us that the value of the home’s list price just. isn’t. there.
Perception is reality.
The next two market indicators really go hand-in-hand. While DOM will help you understand the speed of the market, absorption rate and inventory will tell you how competitive you can expect the market to be.
Defining Absorption Rate and Inventory
Absorption rate refers to the number of homes being sold in a market. As a reminder, a “market” is defined by whatever parameters you apply to it. Will the market for 5-bedroom homes look different than the one for 2-bedroom homes? You bet it will.
You can find the absorption rate by taking the total number of homes sold within a given period, usually 6 or 12 months, and dividing by the number of months. That will tell you how many homes are being sold in that market per month, or the market absorption rate.
For example, let’s say a particular neighborhood of interest to you has had 15 homes sell in the last 6 months. The absorption rate for that neighborhood would be 2.5 homes/month. Now, granted, that’s just a number; it doesn’t indicate anything about market conditions, let alone tell you how to respond.
It isn’t until you have some context that the absorption rate has any significance. The context to consider here is the current inventory.
Inventory is just a term that realtors and other industry professionals use to refer to the number of active listings in a given market. Once a home is under contract to sell (you might hear this referred to as “in escrow” or “pending”), it’s no longer part of the active inventory. Makes sense, right? If you asked a retailer to hold a shirt behind the counter for you, you would hope that they wouldn’t count it in their inventory, wouldn’t you (remember lay-away anyone)? The same principles apply here.
So if you know the absorption rate for a market, and the current inventory, you can determine how competitive the market is.
Understanding and Applying Absorption Rate and Inventory
A balanced market is widely considered to be six months of inventory.
Once a market enters just four months of inventory, it’s considered a seller’s market because the sellers in that market are in the driver’s seat for negotiations. There aren’t enough homes for sale to keep pace with the number of buyers who want to buy them, so the ones with the asset (the sellers) are the ones in control. Once active inventory gets above seven months, it’s considered a buyer’s market, for the same reason: there aren’t enough buyers in the market for the number of homes that are for sale. Supply and demand.
Using our previous example neighborhood, let’s say there are currently three homes for sale. Since our absorption rate over the previous six months is 2.5 homes, that means there is currently just 1-2 months of inventory on the market. Hello seller’s market! I’ll bet the DOM for the neighborhood hover around 20 days or fewer, too.
As a buyer, you want to know what type of environment you’re entering in order to understand how to position yourself within it. When inventory is low and DOM are short, you know you need to make time to see houses as soon as they hit the market, get your financing as far down the road as possible, and collaborate with your real estate agent on other ways to make your purchase offers attractive. It’s a seller’s market, and you’re competing against more buyers than there are houses for sale.
Sellers, read the inventory and absorption rate to help you determine pricing.
If inventory is low, take advantage of that by pricing towards the top of what market will support. You can use the absorption rate to tell you what it will take to be the “next home sold.” If your market seems to have a consistent absorption rate of three homes/month, how can you ensure that your listing will be one of the next ones to sell? By making sure you’re one of the three lowest priced homes.
Price isn’t always the issue, but it’s always a solution.
Defining a Market
We’ve said a number of times that a market is defined by whatever parameters you give it, so it’s really important to make sure that you’re accurate in your market definition. Location, size, price, property taxes, lot size, age, land usage, bedrooms and bathrooms: all these things and more help define a market, but you have to be careful not to over-define your market.
You might find that it’s not the neighborhood specifically that attracts buyers to your area, but the elementary school zoning that drives demand and defines your market. Suddenly the competition, or inventory, for similar-sized homes has tripled.
Work with an experienced agent who can help you determine these things, and one who already knows what these market indicators can tell you about the market you’re about to enter.