The Buyer's Market

"In It for the Long Haul"

The spring and summer months are typically the busiest time for real estate, but the hoped for rebound in the market has yet to occur.  Many had suggested the rebound would occur this year, but now that it's obviously not, next year is the favored target.  While we will likely see a rebound in the number of sales, I would suggest that the Twin Cities' buyer's market may be here for a long time.

A buyer's market literally means there are more sellers than buyers.  A buyer's market does not necessarily mean a "bust" or "crash", which would involve significant value declines.  In fact, the Twin Cities and national markets have a history of buyer's markets that do not involve significant (or any) value declines.

There are some strong indicators that point to a likely long term buyers market.  Over the past 40 years the Twin Cities real estate market has moved in very clear price cycles, from boom to down (buyers) market to boom.  These cycles have tended to last ten or more years.  We are in the second year, or early stage of the current buyers market.  During the last buyers market, average prices rose just 23.88% from 1981 to 1991.  Some submarkets showed comfortable increases, and some lost ground.

The primary fuel of the recent boom (that ended in 2005) was a supply/demand imbalance.  The relationship between the supply/demand ratios and price appreciation has followed a clear pattern for nearly two decades.  Taking the ratio of sales to listings, you will see a strong growth pattern beginning in 1990 and then peaking in 1999-2000.  The ratio then started a steep decline in 2001, and has been dropping since.  The peak was extremely high, holding above 80% for two years.  And although the decline has been steep, it wasn't until 2006 that it dropped below 50%.  These supply/demand dynamics have been the dominant factor affecting real estate prices during this time.  The pattern since 1990 is that the price growth trend follows, or responds to the supply/demand trend.

The sales to listing ratio is still in decline, for the seventh straight year.  When the ratio hits bottom and starts to increase, it may take a few years to reach a high level and have a positive effect on prices.  If the ratio remains low, prices will likely remain flat.  It is important to note that when the ratio declines or is at a low level, price growth slows or stops, but prices do not necessarily decline.

Real estate and other free markets follow certain economic rules or universal laws.  Included is the law of supply and demand, which relates to the powerful principle of balance.  Markets seek balance.  This doesn't necessarily mean that prices must come down after huge increases, but it does mean that excesses created in a boom must be worked out.  This working out could be rapid or it could spread out over a long period.  Real estate is not a liquid asset like currency or stocks, it's a much slower market, and excesses tend to be worked out over a longer period. 

Another indicator pointing to a long term buyers market is the home price to income ratio*.   Home prices rose so much faster during the boom than inflation, leading to historic highs in the home price to median income ratio.  This ratio must retreat to a reasonable balance.  This will occur by either a drop in home prices or an increase in incomes.  Since the Housing Affordability Index (HAI) is in a reasonable range due to low interest rates, my bet is that the balancing will occur primarily by rising incomes.  In other words, incomes and rents have to catch up to home prices before prices can start rising again with any significance.  Since wage inflation is tame due to overseas competition, this process could take a long time.  So while prices don't necessarily fall after a boom, their ratio to median income will fall if it becomes excessive.

The principle of balance will never change, but the numbers that represent a balanced supply/demand or price to income ratio can change.  For example, if interest rates stay low for the long term, than perhaps the price to income ratio will be in balance at a point that is higher than historic norms.  So while the price to income ratio is clearly excessive and must come down, the point that it must reach for balance is unclear.  My guess is that it will take at least five years of relatively flat prices to work out this excess.  Whenever we reach that point, price appreciation will likely resume a more normal pattern (not a boom).

*The MSA Twin City average home price to Hennepin County median household income ratio reached 4.63 in 2004.  By contrast, it was at 2.8 in 1993.  (Unfortunately I don't have historical Twin City MSA income data, so I used the highly populated, income diverse, Hennepin County)

Conclusion

Predicting the future isn't easy, and as time goes on, factors that were previously unknown or underestimated become important.  The real estate market in the Twin Cities currently has no significant upward price pressure.  The price to income, and sales to listings ratios both indicate that we are years away from any real price appreciation.  We are in the early stages of this cycle and the decades old pattern is for the cycles to last ten or more years.  Housing affordability is still reasonable due to low interest rates, and combined with inflation, should keep home prices from falling.  Barring a significant change in interest rates or inflation, we are likely locked into a pattern of low to no appreciation for the foreseeable future.

This is a much healthier and more stable market than the boom of a few years ago.  The correctional period we are going through and the ensuing buyers market should set the stage for long term, slow and steady expansion.  Buyers have many options to choose from and time to make decisions, and prices are not likely to increase too fast and become unaffordable for future buyers.  A few years ago many people bought poor quality houses because they felt compelled to invest in real estate.  Now and in the future, people will buy houses for the right reason.  Your house is your home, your abode, your sanctuary.  The fact that it is one of the few personal possessions that doubles as an investment is a side benefit.  No one should expect to make quick money from their home.  But if you're in it for the long haul, the rewards should be great.

Pat Paulson, Realtor

June, 2007

P777p@aol.com

612 386-8902

Most of the data cited in this article and used by the author to draw conclusions comes from the Minneapolis Area Association of Realtors.  Other sources include the Census Bureau.  The opinions stated and conclusions drawn are solely those of the author.