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Three Cents Worth: Your Gain Is Your Loss (in Volatility)

[This week, (ch)artist Jonathan Miller examines the vexing relationship between inventory and sales price. There are a lot of peaks and valleys, and sometimes it's hard to figure out what's going on, but here's the nut: if inventory continues to go up, prices should stabilize. The graph below runs from the first quarter of '01 to the third quarter of '05. We'll let Miller tell you the rest.]

The recent release of our 3Q '05 report became a flashpoint for the changes in the real estate market. I thought it would be interesting to match up the change in listing inventory over the past 5 years ("supply," the red line) with the annual change in the median sales price ("demand," the blue line). What I found is that the recent change (gain) in inventory is expected to slow the pace of median sales price growth next year.

In the third quarter, our market report showed that inventory was 12.8% higher than the prior year quarter. At the same time, the rapidly increasing rate of year-over-year median sales price growth has eased. How does this trend relate to the peaks and valleys of past years?

As the recession began to take hold before 9/11 (3Q 01), a considerable amount of inventory built up and the annual change in median sales price declined. After 9/11, inventory dropped sharply as sellers pulled their listings and the change in median sales prices dropped even further. Part of this change was exaggerated by the surge in entry-level sales, stimulated by the drop in mortgage rates.

The change in median sales price has trended upward since the low point of 1Q 02, spurred on by falling mortgage rates and renewed confidence in the market. This growth was interrupted by the peak in inventory in the second half of 2002, when the economy began to slip and there was considerable anxiety over the looming Iraq conflict, which began at the end of 1Q 03.

The fluctuation in inventory eased over the past two years, as you can see from the reduced spread between the peaks and troughs. The amount of net inventory currently is 1076 units, the highest since 3Q 02. The upward tend in the rate of year-over-year change in median sales price has also gradually increased through 3Q 05, except for the first half of 2004, when it spiked 34.3% and 31.5% because of a rebound in the real estate market after a weak first half of 2003.

The recent net gain in inventory, if it continues, is expected to temper the rate of year over year gains in median sales price next year. An uptick in supply reduces competition among listings, thereby easing some of the upward pressure on prices. Prices are much less consistent when supply is as constrained as it has been in recent years. Since this condition appears to be changing, a reduction in the volatility of prices may occur. In the long run, that's probably not a bad thing.
· Inventory vs. Median Sales Price [Miller Samuel]