A Softening Market

They say it is impossible to know exactly where the housing market is going, but months of supply is one indicator that can help foreshadow price trends.

Months of supply is a reflection of both supply and demand. When months of supply is low, prices tend to rise. When months of supply increases, price growth typically slows, and if inventory remains elevated long enough, prices are more likely to flatten or decline, but there is a lag between changes in months of supply and changes in home prices. A Richmond Fed analysis found that the strongest relationship occurred at approximately a 10-12-month lag. In other words, if months of supply rises sharply today, it may take almost a year months before the effect is reflected in closed sale prices. This is shown below.

Periods with lower months of supply generally correspond with stronger home price growth, while periods with higher months of supply tend to be followed by weaker price growth or price declines. The following graph shows this relationship more clearly.

The above graph is from The Richmond Fed. It is important to note that the national indicator shown in the graph is based on new construction. We compared new construction months of supply with the overall market and found that new construction has averaged approximately 0.75 months higher than the overall market. Whatcom County has averaged approximately 4.0 months of supply over the past three months, which would translate to about 4.75 months on the new-construction scale shown in the graph above.

Based on the national relationship, that level of supply still suggests some potential for home price appreciation, though likely at a slower pace. Historically, markets in this range have often seen price growth in the 1% to 6% range. Home prices do not appear to decline consistently until months of supply rises above approximately 10 months, but the risk of price declines increases as supply continues to rise.

That said, the local market is in a unique position. Affordability remains a major constraint. Home prices are high relative to median income, and mortgage rates remain elevated compared to the very low rates seen several years ago. This may help explain why Whatcom County home prices are essentially flat year-over-year, even though months of supply has not reached a level that would normally suggest broad price declines.

The local market continues to soften, however. The supply has continued to increase over the past three years and doesn't appear to be slowing down. At the current pace the months of supply would be at 5.0 in two years and 6.0 in four years.

Many variables can redirect the current trend above, so let's not assume it will continue.

The takeaway is that the market has softened, but is still a balanced market. Prices are flat, but we will keep an eye on the continued increase in the months of supply and its impact on prices.