Buyers Market vs Sellers Market: Forecasting Trends

There is a common refrain that is being echoed among industry types when asked if it is a buyers market or sellers market:

 

 

 

That’s right, we are all…currently… existing in a sellers market.

Ok, I know, this is not ground breaking news. In reality, knowing whether you are in a sellers market or a buyer’s market in real estate is not all that important. Sure the market has an impact on price and investment strategies, but anyone who is actually operating in the market understands its basic economy.

Therefore, I don’t think we need to do a deep dive into the specifics of what makes up a sellers market and how to invest during this period. You should be able to find about 25 articles with 5 Biggest Mistakes To Avoid When Investing In A Seller’s Market, so I don’t want to waste my time on that either.

Instead, I want to look into what actually causes the market to shift, in order to see if there are any signs that we can look at to accurately predict market movement. To be clear, I am not looking for all of the signs and triggers, since there is more to consider than any one aspect of the marketplace, but instead, I am looking for one or two signals that can alert astute and attentive investors that the market is due for a shift.

However, as I sit down to write this, I think there is still a need to define our markets and base assumptions first, to ensure that we are all referring to the same topics and understand the core principles that we will expand on throughout this article.

What is a Buyer’s Market

The core concept of a buyer’s market in real estate is that the number of homes for sale exceeds the number of prospective home buyers, thus giving the interested home buyer’s leverage when it comes to negotiations.

In this market, the purchasers have an advantage over the sellers, and therefore, we should see homes being sold for less than we would normally expect.

What is a Sellers Market

At the risk of sounding redundant already, the seller’s market is the exact opposite of the buyer’s market since both are simply functions of the supply and demand formula.

So, a sellers market means that the demand for buying homes exceeds the supply of homes on the market, thus seeing home prices rise as sellers are able to create bidding wars for the limited homes that are for sale.

 

Key Components of the Market

The supply for housing is a function of cost to produce a home versus price of existing homes. In a sellers market, the demand is greater than the supply, which results in the price of homes going up.

 

In the chart on the left, we see that demand shifts the curve to the right, so if there is no change in supply, then the price has to increase which is why the market prices go up in a sellers market.

The graph on the right compares construction costs to the value of the home. In a sellers market, the value of the homes are high compared to construction costs, and this will catalyze construction. More new construction permits means that we can tangibly see the market equalizing itself.

But again, what does this mean?

Have I just wasted 500 words on telling you that we are in a sellers market and here are two graphs that are confusing as all hell to understand even after you read what each was about? You’re damn right I did!

In all seriousness, the goal of the last few sections was simply to ensure that we are all on the same page for the rest of the article. Therefore, let’s lay out our conclusions so far:

• The buyer’s and sellers market is a function of supply and demand;
• Most industry professionals agree that we are in a sellers market currently;
• There are clear connections between the shifting markets and residential construction, due to the basic supply and demand equation.

With these points being our starting spot, and our goal being to establish if we can accurately predict a change to the market in order to better position our investment timing, I think the first step is to definitively prove that we are in fact in a sellers market.

Are We in a Sellers Market?

Ok, so this should be pretty easy to prove, so let’s first start by sharing a few of the myriad of articles that discuss this very topic:

• “Essentially, all numbers point to a seller’s market for the current housing market. A real estate investor selling an investment property has more negotiating power than one buying an investment property.” Mashvisor.com
• “This year, given how overheated (some economists say) the market is, we’re not sure any price a seller could dream up would be too high.” Washington Post

Just to be sure, let’s take a peek at some of the data ourselves just to make sure what we are seeing matches up with what the masses are saying.

Well, based on what we discussed about the market earlier, it would make sense to start our search by looking at the inventory on the market, so let’s see how many homes are for sale. [Source: Redfin.com]

 

As you can see in the above graph, the supply of homes that are out on the market has been decreasing, with a severe low point in November and December of 2017. In addition to this, the houses that are on the market are being sold quicker:

 

 

Meanwhile, the prices of homes are increasing, as we see more homes are being sold over their asking price:

 

 

This information tells us that we are in fact in a sellers market currently. There are less homes for sale, the homes that are for sale are not spending as much time on the market as they used to, and a higher percentage of them are being sold over asking price.

What are Some Signs That the Market is Changing?

Now that we know it is a sellers market, we should be looking for signs that indicate a switch to a buyer’s market because there is opportunity where there is change.

The first place we looked was how construction companies were fairing.

The core concept of this search is that if residential construction companies have an increase in building contracts, they will make more money, which will increase their stock prices. When their stock prices go up, we can insinuate that more homes, or inventory, will hit the market shortly thereafter.

Ok, so let’s get to the support.

First, I wanted to see what the trend looked like for the number of new homes that are for sale over the previous 5 years.

Ok, before we get to some stock prices, let’s first analyze what this graph is telling us.

First, let’s address what was my first question when I saw this, which is that I just saw a graph above that said there was a downward trend in the number of homes for sale, but this chart is showing a positive trends. The difference is that this is showing how many NEW homes are for sale, while the graph above is how many new and existing homes are for sale.

Moving onto what it shows us, we learn that there has been a noticeable increase in the number of new homes for sale over the past few years.

We also see that there are a couple of dips along the way, so let’s take note of a couple of dips in order to compare that to our companies’ stock prices.

Focus Areas:

• February 2014 – September 2014
  • • There looks to be a pretty large increase in the number of homes for sale over these 7 months.
• August 2014 – February 2015
  • • There looks to be a drop in homes for sale over these 6 months.
• June 2016 – July 2016
  • • There is a slight drop here, but given the size of the drop over the short time span of 1 month, it is worth looking into.
• July 2016 – Current
  • There is a steady rise over these roughly 18 months.

Alright, now we are ready to dive into some financials. For this exercise, I chose to focus on two of the largest residential construction companies in America, Toll Brothers and Lennar Corp., and track how their stock prices performed in relation to the homes available for sale.

 

It’s ok, relax, I know these graphs can be a bit overwhelming to just jump right into, so let’s just simplify what we are doing with this and only look to see if there are any connections we see in the prices of these companies’ stock as to when the market will begin to shift.

Now, let me preface this by warning you, you are about to see a bunch of excel images. DO NOT BE ALARMED!

Just focus on the bolded areas, anything highlighted gray and green, these are our key areas to focus on. The sections above each image will clue you in on what numbers to look for, and again, you are only looking for trends.

What we see is:

• August 2013 – February 2014
  • Toll Brothers saw a big increase over these six months, with their stock price going from $30.61 to $39.01, an increase of 27.4%.
  • Similarly, Lennar Corp. saw their stock price rise from $31.28 to $43.15 over the same time period.
    • This is the period directly before the number of new homes had their big increase from February 2014 through September 2014.

• February 2014 – September 2014
  • Toll Brothers experienced a slight drop of -20.12% in their stock prices over these 7 months.
  • Meanwhile, Lennar Corp. saw a dip of -11.52% in their stock prices over the same time period.
    • This is right before a 6 month period in which the number of new homes for sale dropped by close to 4%.

• November 2015 – February 2016
  • Toll Brothers and Lennar both experienced a large drop in their stock prices, with Toll Brothers taking a -26.17% dip in their stock while Lennar only suffered an -18.09% drop over just a 3 month timespan.
    • Here we see a slight drop in the number of new homes for sale as well, of just under 3% over the course of a month, but the modest drop compared to the large dip that the construction companies took is interesting.
    • However, this is most likely explained as a fact that we are analyzing a market by looking at isolated companies. When the largest companies in a sector experience growth, the market tends to grow in a similar fashion. However, when one or two of the large companies have a down fiscal quarter, the market tends not to feel the loss as noticeably. This is due simply to there being other companies that might be sustaining the market. We simply don’t have enough data to really make any concrete determinations.

• October 2016 – November 2017
  • There have been large gains for both companies, with Toll Brothers seeing their stock increase to over $50 a share while Lennar got close to $63.
    • The number of new homes for sale has risen steadily from July 2016 though March 2018, increasing by over 25% in an 18 month timespan.

 

So, with this information in hand, it is clear to see that the successes that the largest construction companies in the country have will trigger market change. We see that, when the construction companies experienced increased profitability, it signaled that more homes would be built over the following period.

We also notice that the market reacts less severely to a down quarter than it does to a positive quarter from these companies.

All of this should make sense, as when large residential construction companies get more contracts to build homes, they make more money, which increases the value of their stock. So, when we see the stock rise, that means that that company got more work, and so I would anticipate seeing more buildings on the market, which will have a direct impact on our supply and demand equation.

Making Moves From This Data

By this point, you might be thinking that I forgot the basic point of this article, which was to identify if there was a specific sign that we could look to in order to make strategic decisions off of.

Therefore, let’s get into that.

After taking in the data from above, the story that this information is telling me is when we see the stock prices of these companies increase for, say, a 3 month period month over month, there is a good reason to believe the following 3 months will see an increase in the total number of new homes for sale.

The next part of this equation is to find a way to track the number of existing homes for sale in order to understand how much supply will be on the market.

Again, let’s just remind ourselves, currently we know that the market is a seller’s market because:

• Over the first quarter of this year, the number of existing homes for sale has increased every year by 60-90 thousand a month.
  • Sign of shift: The last time June experienced an increase in existing homes for sale over the previous month was in 2014. Since then, every June has seen a decrease month over month after at least 5 months prior of increases.

• Meanwhile the number of new homes for sale have increased every month since May of 2017.
  • Sign of shift: However, the stock prices of our two test companies have been consistently decreasing month over month since the end of 2017.

This tells me that there is a shift coming in the market, as I would anticipate to see less new homes available for sale due to the decreased stock of our constructions companies while I would also expect to see a decrease in the number of existing homes for sale seeing as historical data suggests June is a month in which we typically see a decrease.

However, this is all being done from a national perspective. Therefore, I highly recommend you look into doing this research for yourself in order to get a local perspective for your area, as that is ALWAYS a more accurate approach.

Signs to Monitor

• Past prices of homes – Look at recent sales to see if you can notice when prices begin to rise incrementally. You can compare the timing of any price change you notice with the graph above in order to see if you are noticing a price increase at the same time the national average increases as well, or if there is a real opportunity there for you.
• Local Household Income/Population Growth – Understanding the demographic changes can be absolutely critical to understanding the market state, so look to understand the types of residents in an area.
• New Construction Permits – Construction of new homes has been identified on the macro scale through the monitoring of the largest residential construction companies’ stock prices in order to establish if they are obtaining contracts to build, which would bring with them large increases in the value of the company’s stock.
• Vacancy rates – Simply put, with high vacancy comes too much supply.
• Price of Rehabs – Understanding how much supplies are costing, you can better understand the profitability of residential construction companies.