In response to historic inflation sponsored by unchecked COVID transfer payments, the Federal Reserve Bank initiated policy in March 2022 to bring inflation under control. A visible component of this policy – especially to anyone involved in real estate – is increased interest rates. Mothballed phrases like “buying points” – unuttered since prime rates dropped and stayed at 3.25% throughout most of the last decade – are back in vogue with real estate agents trying to ink deals on during growing housing inventory[1].
Since the government embarked on interest rate increases, Abilene inventory has mirror national trends in its expansion. On the day prior to the quarter-point prime rate increase on March 17, 2022, Abilene housing inventory stood at 2.08 months. Subsequent to this year’s five rate increases, housing inventory climbed throughout 2022, recently doubling to 4 months of inventory[2].
So… 4 months of inventory and climbing with more interest rate increases likely to come. Not to get mired in the present, I looked for historical opinions and data on housing inventory to lend long run context:
- I was curious what level of real estate inventory makes a neutral housing market – that is, a housing inventory that gives neither a seller nor buyer the upper hand. The Texas Real Estate Center at Texas A&M offers 6.5 months as neutral inventory.
- In Abilene, we have to go back to 2014 to see inventory above 6.5 months and, even then, +6.5 months of inventory only occurred in January – a time in the calendar acknowledged as a slow time for real estate transactions. These periods of neutral inventory were short-lived and inventory quickly returned to a position that benefitted sellers. Unlike current conditions, those blips took place during a prolonged period of 2% inflation and prime rates at 3.25%.
- Following 2014, a strong economy with predictable 2% inflation gave the government the green light to raise rates, ultimately, to 5.5%. A rate reversal was initiated in July 2019 and the following January saw inventory momentarily climb above the winter spike realized in 2018 and 2017 under these higher interest rates. Then COVID hit, people sheltered in place afraid to put their house on the market or look at houses, inventory climbed to 3.92 months in June 2020, the prime rate was cut to 3.25%, and PPP money was infused into the economy. The result: as we learned to live with pandemic conditions, we saw sub-2 month inventory occur 50 times between January 2021 to March 2022 and we experienced the most persistent seller’s market seen in years.
Historical data shows four (and more) months of inventory is nothing new to buyers over the last decade, but this is the first time in many years that we’ve seen rising inventory in tandem with rising rates and rising inflation. Over the past two years, transactions were simple and had only a few moving parts – sellers expected they could price high and buyers knew they would have to fight to pay these higher prices. Changing inventory is changing how sellers (and real estate agents) will have to price to appeal to buyers.
As a broker, this is what caused me to give a hard look at the role of inventory on price. I need to understand how to price so I can provide value to sellers and help buyers negotiate better deals in the current economic climate.
To measure how inventory affects pricing, I looked at closed Abilene sales dating back to January 1, 2010 – a total of 18,464 closed transactions. Because these figures took place across time, I had to adjust price and other dollarized records using a price deflator to bring past sales into current or real terms. Inventory was the primary variable I wanted to translate into sold price, but other factors have more bearing on the price of a single-family home sale. To capture those other factors I considered:
- Square footage – larger homes, bigger price.
- Age of home at date of sales – the older the home, the lower the value of the home.
- Age *Age – this polynomial transformation measures gentrification. True, older homes lose value, but as they age, trees get bigger, neighborhoods become more established, and values increase.
- Unexempt property taxes – A problem with age, especially old age, is that it fails to measure a home’s condition – you can have two homes of the same age where one is old and decrepit, and the other is old and well-maintained. Using unexempt taxes presumes that an agent of the tax office lays eyes on each property and judges its condition on a spectrum from excellent to poor. This allows unexempt taxes to serve as a proxy for quality.
- Lot size (measured in acres) – the larger the lot size, the larger the value.
- Pool (Y / N) – a swimming pool adds value.
- Number of stories – a second floor decreases value, a third even more so. People in Abilene don’t like to climb stairs.
- Wylie ISD – Wylie ISD adds value relative to Abilene ISD.
- Mandatory HOA – an HOA is an additional agent that maintains quality of a neighborhood and adds value.Half baths – a half bath is a proxy for higher end construction and adds value.
- Number of garage stalls – this adds value as people appreciate protection afforded by an enclosed garage. This is not the same thing as carport parking.
- No HVAC – no HVAC suggests a total gut job and subtracts value.
- Luxury vinyl plank – this newer flooring suggests the home owner has made an effort to update their home which adds value.
- Number of months inventory – every month of inventory added gives advantage to buyers, decreasing price.
A linear regression explaining real closed price was performed with this list of 14 independent variables explaining close price. The model appeared to be a good fit and all 14 variables were statistically significant in their ability to explain closed price. The model also estimated that a gain in housing inventory by one month translated to a drop in price by $15257.20. All other factors held constant, a home on the market in October 2022 (using inventory measured on 10/18 of 4.09) lost $30,666.90 versus what it could have sold for if it went under contract instead on January 1, 2022 (inventory 2.08 months).
[1] The number of homes that are actively on the market divided by the number of homes that sold in the last month is the formal measure of inventory. For example, if 400 homes are on the market and 100 homes sold in the last 30 days, inventory is 4 months. This statistic suggests if consumers take down 100 homes per month, there are enough homes on market to sustain 4 months of purchasing.
[2] To find another period with four months of inventory, we must return to the early days of COVID in March 2020. It was during this same month that interest rates dropped and stayed at 3.25% for 24 months, ending with the first of five rate increases in March 2022 followed by rate hikes in May, June, August and September.
