It's The Inventory, Stupid

If you get nothing else from this article, remember this, you need to understand the direction and speed of a market before you invest in real estate.

What I mean by the speed and direction of a marketplace is what is the current relationship between the supply and demand for real estate? Is this relationship improving or getting worse?

If you know the answer to these two questions, you know whether it is a safe time to be investing in that real estate market.

The truth is, and it is unlikely you will get this information from local real estate agents, but there are some real estate markets you are not going to want to invest in. The reason you are not going to want to invest in these markets is because you will lose money, at least in the short term. You will lose money because the housing supply and demand trends are such that the supply of housing continues to increase at a greater rate than the demand, the market has not hit bottom yet. And until a market hits bottom, properties will continue to lose value.

For example, when you talk about the supply and demand for real estate, what you are really talking about is the month’s supply of housing. The month’s supply of housing is the barometer by which you need to measure real estate markets. So let’s say a market has a 9 month supply of housing today (A 6 month supply of housing is a balanced market). This tells us that there is an oversupply of houses, but it doesn’t tell us the direction of the market, it only tells us where we are today. This may or may not be a good time to buy, we don’t know yet.

But let’s say we knew that last month there was a 10 month supply of housing, and the month before that there was an 11 month supply, and the month before that there was a 12 month supply. This would indicate to us that the three month trend is that the excess supply of housing is being absorbed. So while a 9 month supply of housing may not look good at face value, by knowing the monthly trends, we can feel confident that we are investing in a market that has already hit bottom and is now rebounding. This is a good thing.

Now, on the other hand, if this same market had a 6 month supply of housing three months ago, and then a 7 month supply two months ago, and an 8 month supply last month, this also tells us something. It tells us that the trend is that the market has not yet hit bottom and it is continuing to experience downward pressure on property values. This is a bad thing.

So at face value, a nine month supply of housing may look like a good time to get off the fence and invest when property values have declined from their high-water mark and you can find a good “deal”, you need to make sure that the monthly supply and demand trend favors a rebound as opposed to a continuing recession.