Supply Goes Up, Prices Come Down. It’s that Simple

Supply goes up, prices come down. It's that simple. The big question in real estate is what will happen with home prices over the next few months. The experts have already weighed-in predicting prices will probably take another dip. Their reasoning? Put simply, the inventory of homes on the market is greater than the demand for housing.

Demand will remain stable at best. No study or report is predicting a dramatic increase in demand over the previous estimates. PMI, Inc. is actually cutting their forecast back. In their most recent issue of The Home and Mortgage Market Review they announced:

"We have lowered our projection of home sales for 2010 in response to the larger-than-expected decline in sales in May."

If demand doesn't increase, the supply of inventory will determine future prices. Here is a great industry guideline that has withstood the test of time:

• 1-4 months inventory means it's a seller's market and we can expect appreciation.
• 5-6 months inventory means it is a balanced market with prices following inflation.
• 7+ inventory means it's a buyer's market and we can expect depreciation.

According to the National Association of Realtors (NAR), there is currently an 8.9 month supply of housing inventory on the market. Here is a graph showing how the month's supply of inventory has increased since last November:

Calculated Risk addressed this point recently by saying:

"For July, if sales fall to 4.5 million (it could be lower) and inventory is still at 3.9 million units, months of supply will rise to 10.4 months. I think these estimates are conservative (actual will probably be higher). For reference, the all time record high was 11.2 months of supply in 2008. This level of supply will put additional downward pressure on house prices."

Couple this with the fact that banks will repossess approximately a million foreclosed homes this year and you realize the supply of housing inventory could jump to numbers close to those we experienced when home prices were falling dramatically.

We must keep an eye on the month's supply of inventory to determine where housing prices are headed.