Real Estate "Inventory"

People forget it's a moving target

Dave Ramsey and others have been insisting that real estate cannot possibly crash despite price appreciation and mortgage rates raising the median payment by almost 80% over the last year. Their argument is that a) lending standards are much improved since the 2008 crisis (true), b) most people refinanced at low rates and will not want to sell to preserve that lower payment, removing inventory at the margin from the market (true), and c) there is already an undersupply of housing available in terms of months of inventory (true), therefore the affordability issue will not result in a decline in prices. Ramsey seems to think prices will remain flat for a few years, which of course given inflation is really an effective price decline relative to other assets, but is not worried about a crash in nominal prices.

I’m not so confident. As Ramsey ought to know, the most effective economic model of the typical consumer is someone who will borrow and spend as much as possible. Most people who buy houses simply buy the nicest one for which the bank will lend based on their income to payment ratios. With mortgage rates up, there are fewer buyers at the margin for every property, particularly those above the median home.

The issue I see is that the metric everyone points to, months of inventory, is a fraction with both a numerator and denominator. It’s houses for sales divided by the number of sales that month. “Months of inventory” can go up by either the number of houses for sale going up OR the number of monthly sales going down. In other words, the number of houses for sale can stay the same while the pace of sales slows as fewer people can qualify to buy them. Then the question becomes who blinks first. With an illiquid asset like real estate, typically there are always more forced sellers than forced buyers. An excess of buyers is usually speculation-driven like we saw in 2021, but few of those paying above the asking price truly needed to buy; they were just afraid of missing out. But sellers often must sell for economic reasons.

So if the pace of sales slows significantly, we could quickly be back in a buyer’s market (6+ months of inventory) even without additional homes coming on the market. If this spooks sellers, who want to get out before a potential decline in prices, and a bunch of inventory comes into the market while transaction volume declines, we could see a decline in nominal prices. Buyers might also take their time and make lowball offers if they anticipate further price declines. Given the background inflation that’s already happening, declines might be modest, perhaps 20% max, but in inflation-adjusted terms, it could very easily match the 2008 crisis. I think the Fed would like such an outcome. A controlled 10-20% nominal decline in prices hurts the middle class and drives down inflation in consumer spending while leaving their banking clients’ collateral untouched.