Months of supply

What Is Months of Supply?

Months of supply is a key metric in real estate market analysis that measures how long it would take for the current inventory of homes on the market to be sold given the current pace of sales volume, assuming no new properties are added. It provides a snapshot of the balance between supply and demand within a specific real estate market, helping to indicate whether conditions favor buyers or sellers.

History and Origin

The concept of months of supply emerged as a practical tool for real estate professionals to gauge market equilibrium. While its precise invention date is not formally documented, its adoption became widespread as the analysis of housing market statistics became more sophisticated. Organizations such as the National Association of REALTORS® (NAR) began tracking and reporting this metric as early as 1999, providing crucial data for understanding prevailing market conditions. The metric provides a clear, digestible figure for the public and industry insiders alike to quickly assess the market’s velocity and the availability of homes. The National Association of REALTORS® details how months of supply measures housing supply alongside inventory levels.

##⁷ Key Takeaways

• Months of supply indicates the hypothetical time it would take to sell all current listings at the prevailing sales rate.
• It serves as a critical indicator of the balance between supply and demand in the housing market.
• A lower months of supply generally signifies a seller's market, while a higher figure indicates a buyer's market.
• Industry standards often consider approximately six months of supply as indicative of a balanced market.
• The metric is utilized by real estate agents, economists, and potential buyers and sellers to inform strategic decisions.

Formula and Calculation

The calculation for months of supply is straightforward, dividing the total number of available homes for sale by the average number of homes sold per month.

The formula is:

$\text{Months of Supply} = \frac{\text{Total Inventory of Homes For Sale}}{\text{Average Monthly Sales}}$

Where:

• Total Inventory of Homes For Sale: The total number of active listings available on the market at a given point in time. This is a count of properties listed for sale, often collected at the end of a reporting period.
• Average Monthly Sales: The average number of homes that have successfully sold each month over a specified period, typically the past 3 to 12 months. This smooths out short-term fluctuations in sales volume.

Interpreting the Months of Supply

Interpreting months of supply involves understanding what different ranges signify for the real estate market. This metric provides insight into the competitive landscape and potential direction of home prices.

• Seller's Market (Less than 5-6 months of supply): When the months of supply is low, it indicates that demand outstrips supply. In such a market, homes tend to sell quickly, often receiving multiple offers and potentially selling above asking price. This environment generally favors sellers.
• Balanced Market (Approximately 5-7 months of supply): This range suggests a relatively even balance between the number of available homes and the rate at which they are being sold. Prices tend to be stable, and negotiations are more typical. Both buyers and sellers have reasonable leverage. Industry experts, including the National Association of REALTORS®, commonly associate six months of supply with a market in equilibrium.
• ⁶Buyer's Market (More than 7 months of supply): A high months of supply indicates that there are more homes for sale than there are buyers. This creates more options for buyers, who may have more leverage to negotiate prices or request concessions. Homes may take longer to sell, and prices might stabilize or even decline.

This interpretation helps all participants in the housing market understand the prevailing dynamics and tailor their strategies accordingly.

Hypothetical Example

Consider a hypothetical suburban housing market, "Maplewood Estates," at the end of July.

1. Determine Total Inventory: On July 31st, there are 150 homes actively listed for sale in Maplewood Estates.
2. Calculate Average Monthly Sales: Over the past six months (February to July), the total number of homes sold was 600. To find the average monthly sales, divide 600 by 6, which equals 100 homes per month.

Now, apply the months of supply formula:

$\text{Months of Supply} = \frac{150 \text{ (Total Inventory)}}{100 \text{ (Average Monthly Sales)}} = 1.5 \text{ months}$

In this example, Maplewood Estates has a 1.5 months of supply. This very low figure indicates a strong seller's market, where homes are selling rapidly, and buyers face limited choices and potentially intense competition. This scenario often leads to upward pressure on home prices.

Practical Applications

Months of supply serves as a vital economic indicator with several practical applications across different facets of the financial world:

• Real Estate Investing: Investors use months of supply to identify opportune markets for buying or selling. A low supply might indicate potential for price appreciation, while high supply could signal a good time for distressed property acquisition. This helps in forecasting market trends.
• Mortgage Lending: Lenders monitor months of supply to assess market risk. In areas with rapidly decreasing supply, competition among buyers might lead to inflated valuations, which could impact loan-to-value ratios and default risks. Conversely, high supply might suggest a more stable or declining market, influencing appraisal practices.
• Construction and Development: Homebuilders and developers rely on this metric to inform decisions regarding new housing starts. A low months of supply can signal unmet demand, encouraging new construction, while an increasing supply might prompt a slowdown in new projects. The U.S. Census Bureau provides data on new residential sales, including months of supply for new houses.
• ⁵Economic Analysis: Central banks and economists track months of supply as a gauge of overall economic health. Significant shifts in housing supply can impact consumer confidence, spending, and broader economic stability, often influenced by factors like interest rates. Data on housing inventory, including active listing counts, is available through sources like Federal Reserve Economic Data (FRED).

⁴Limitations and Criticisms

While a widely used metric, months of supply has certain limitations and faces criticisms that warrant consideration:

• Lagging Indicator: Months of supply is a backward-looking metric, based on past sales and current inventory. It doesn't instantly capture sudden shifts in market sentiment or external economic shocks. By the time a change in months of supply becomes apparent, the market may have already begun to adjust.
• Market Segmentation: A single months of supply figure for an entire region can be misleading. Different segments of a market (e.g., luxury homes, starter homes, condos, single-family homes) can exhibit vastly different supply and demand dynamics. What appears to be a balanced market overall might mask a severe buyer's market in one segment and a strong seller's market in another.
• Data Accuracy and Consistency: The accuracy of the metric depends heavily on the reliability of inventory and sales data. Definitions of "active listing" can vary across different Multiple Listing Services (MLS) or reporting agencies, and sales data might be impacted by reporting delays.
• Exclusion of Pending Sales: Some calculations of months of supply only consider active listings, excluding properties that are under contract but have not yet closed. Including pending sales can provide a more accurate picture of effective inventory, as these homes are effectively off the market. The National Association of REALTORS® clarifies its approach to inventory, which includes both active listings and pending sales in some contexts.
• ³External Factors: The metric does not inherently account for external factors that can significantly influence the market, such as changes in affordability due to shifting interest rates, economic recessions, or policy changes.

Months of Supply vs. Days on Market

Months of supply and days on market are both important metrics in real estate, but they convey different aspects of market activity. Months of supply provides a macro-level view of the overall balance between available homes and buyer demand, indicating how long the current supply would last. It’s a measure of market liquidity from a supply-side perspective. In contrast, days on market (DOM) is a micro-level metric that focuses on the individual property. It measures the number of days a specific property has been listed for sale until it goes under contract. A low DOM indicates that individual homes are selling quickly, reflecting strong demand, while a high DOM suggests slower sales for specific properties. While months of supply helps categorize the general market as a buyer's or seller's market, days on market helps evaluate the attractiveness and pricing of particular listings within that broader context.

FAQs

What is considered a healthy months of supply?

Generally, a healthy or balanced market is often considered to have approximately five to seven months of supply. This range suggests a stable environment where neither buyers nor sellers have an overwhelming advantage.

How does months of supply affect home prices?

A low months of supply typically indicates a competitive seller's market, which can lead to rising home prices due to high demand and limited inventory. Conversely, a high months of supply suggests a buyer's market, which can exert downward pressure on prices or lead to price stabilization.

Is months of supply the same for new and existing homes?

No, months of supply can differ significantly between new construction homes and existing homes. They are often tracked separately because the dynamics of new home sales (influenced by construction pace, permits, and builder strategies) are distinct from existing home sales (influenced by homeowner willingness to sell and resale activity). The Federal Reserve Bank of St. Louis provides separate data series for the months' supply of existing homes and new homes.

Ca¹, ²n months of supply predict a housing market crash?

Months of supply is a valuable economic indicator for assessing current market conditions and potential trends, but it is not a standalone predictor of a housing market crash. While an unsustainably high or rapidly increasing months of supply can signal an oversupplied market, other factors like interest rate changes, employment levels, mortgage lending standards, and broader economic health also play critical roles in determining the future direction of the real estate market.