Housing's Misleading Health Indicator
The National Association of Realtors will release its monthly U.S. existing home sales report tomorrow. Among other things, the report includes what's known as the absorption rate, or how many months it would take to sell all inventory at the current sales pace. This report and the media coverage around it will inevitably provide the well-worn insight that when the rate is less than six months, housing is “healthy.” The current rate is 5.3 months.
After I Googled the phrase “a six month absorption rate is a healthy real estate market,” I found plenty of articles citing this rule of thumb, yet none cited a source. The idea that a market is “healthy” is brokerspeak, and doesn't refer to anything tangible such as sales, prices or inventory. The six-month benchmark incorrectly indicates that all U.S. markets are the same and infers that a lower absorption rate is better than a higher rate. Based on history, we know this isn’t true.
For more than half of the past 15 years the absorption rate has been lower than the six-month threshold, yet this wasn't a sign of a “healthy” market: just the opposite -- it was a sign of a market with a fever. From 1999 to 2006 the faster rate was the precursor to the biggest housing bubble of the modern era, fueled by easy access to credit. From 2012 to 2014 the faster rate was a reflection of tight credit that kept inventory low. Both periods were far from optimal.
Yet there have been some encouraging signs in recent months. The absorption rate has slowed after last year’s frenzied market pace, when the rate flirted with four months. The slowdown has been encouraging, a result of increasing inventory and a slower pace of price increases. This pattern , if it holds, may be the best safeguard to keep the consumer from getting soaked again.
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