The sales-to-inventory ratio is a key measure of our real estate market because it takes both supply and demand into account telling us how balanced our market is.
A sales-to-inventory ratio of 50% means that one in every two houses sold in a given month, a sign of a hot market. A sales-to-inventory ratio of 10% means that only one in every ten houses sold in a given month, a sign of a much cooler real estate market.
The above chart shows Toronto’s monthly sales-to-inventory ratio since 1989.
A sales-to-inventory ratio in the range of 15%-25% suggests a balanced market with little change in house values. A ratio below 15% moves us into Buyer’s market territory and often results in a drop in prices. Values above 25% are a sign of a seller’s market where rising prices are the norm.
The best way to really see the relationship between the sales-to-inventory ratio and changes in home prices is to layer both measures on the same chart. The following chart shows the sales-to-inventory ratio along with the percentage change in home prices for each month.
The first thing that stands out is the high correlation between changes in the sales-to-inventory ratio and changes in house prices. This chart is showing us a basic economic principle at work, how changes in the balance between the supply and demand impacts prices.
We know from Economics 101 that in a balanced market where supply equals demand we reach an economic equilibrium and expect to see virtually no change in prices. Once demand exceeds the supply of goods available, prices begin to rise to adjust for this imbalance. Conversely when the supply of goods exceeds the current demand prices begin to fall.
In the case of the real estate market, we appear to reach an equilibrium level of supply and demand when roughly 2 houses sell for every 10 houses available for sale on the market, or in other words a sales-to-inventory ratio of 20%. Calculating an equilibrium level of supply and demand is not an exact science which is why we tend to use the 15% to 25% range of the sales-to-inventory ratio to show a balanced market.
December 4, 2010Market |