Housing Inventory Is Falling. Why?

If Inventory Is Falling That Means Prices Will Go Up, Right?

Mike Simonsen at Compass shared some interesting new data on trends in the housing market, but because he doesn’t have a timeless and universal model of how it all fits together, I’m not sure what he’s trying to say beyond just sharing some data.

First of all, this looks like a small wiggle in the inventory trend. Secondly, normal seasonal patterns mean that at some point in the next few months, inventory will begin falling for the rest of the year. That all being said, even if this were indicative of a change in trend to unseasonably early falling inventory, it would not represent a change in the narrative of a highly unhealthy housing market. The reason is because of this:

Inventory is falling because sellers are taking their houses off the market, not because they are selling. If the earlier part of the year had been characterized by a buyer’s strike, a seller’s strike has now been added to the mix as well. This is just a return to the frozen market of the past few years — not a lot of buyers, not a lot of sellers, not a lot of transactions.

The reason for this is because of the cost of carry of housing. As a reminder, the three pieces that make up cost of carry are Financing Cost, Storage Cost (or Maintenance Cost), and Convenience Yield.

Financing Cost

The majority of current homeowners are locked into financing costs that are lower than any potential new homebuyer could achieve.

And when I say locked, I mean locked. This is not like the Financial Crisis where mortgage rates will suddenly adjust, causing a cascade of forced selling and defaults.

In general, sellers hold a stronger hand when it comes to financing costs than buyers, meaning they are more able to do things like withdraw their listings and continue to pay the cost of carry while they wait to see if the market turns in their favor.

Storage/Maintenance Costs

Theoretically, these should have no bearing on whether buyers or sellers benefit, because the buyer will just assume them from the seller upon purchase, and this should all factor in to the hurdle rate the buyer is implicitly using to make their purchase decision. In reality, I think these cut doubly against the seller, but only if they are sufficiently high. What I’m talking about when I say Storage/Maintenance costs are things like the insurance premiums and safety rules described in the article here:

The reason I say it cuts doubly against the seller is because the buyer also has to pay them if they purchase the house, so they incorporate them into their hurdle rate, which lowers demand at any given price point. For the seller, they literally have to pay them now. The higher these costs go, the more likely the seller decides they don’t want to pay them any more and should sell. This lowers the hurdle rate to sell, thus raising supply at any given price point. Higher supply and lower demand means lower prices.

Convenience Yield

These are all of the kind of immeasurable factors that also go into the purchase decision. Are we having a cultural moment where everyone thinks owning your own home is great? Is there a global pandemic that is leading urban renters to turn into suburban home buyers? Things like this defintely affect the implicit hurdle rate that buyers and sellers use when deciding to buy/sell a home, but they aren’t really captured by a reliable data series.

So, coming back to the Simonsen thread, it looks like what’s happening is the seller’s strike is a result of the cost of carry not being high enough to force them to sell. For current homeowners, the financial piece is relatively unchanging, so that’s not really a lever than can change anything. That leaves the other two pieces.

Storage Costs - These are clearly rising, as the excerpt in my Tweet shows, but they must not be rising enough to be unbearable. If they were, you’d see growing inventory as current owners would want to sell but prospective buyers wouldn’t want to buy at current prices. There is another possibility, which is that because this is aggregated data we are missing some important regional distinctions. This seems the most likely outcome and warrants further investigation.

Convenience Yield - My pet theory into what is happening actually falls into this bucket. Boomer pride will not allow them to sell at any price below MAX(Zestimate). Mathematically speaking, this means a near infinite Convenience Yield at any price below MAX(Zestimate), which translates to a near infinite hurdle rate to sell (highly negative cost of carry) in that price range as well. Convenience Yield can’t be empirically shown, so we’ll never know for sure, but this is what I think is going on.

Regardless of the cause, this falling inventory that we are seeing is not indicative of a housing market that’s about to boom. The market is sick, and this is just another symptom.

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