My BRB Mortgage › Market mechanics

How a local housing market actually works

A housing market has no order book, no closing bell and no two identical units. What it has is a standing stock of houses, a thin flow of them onto the market, and buyers who arrive and leave on their own schedules. Almost everything else follows from those three facts.

Stock and flow

The stock is every dwelling that exists in a place. It changes very slowly: new building in a normal year adds a fraction of a percent to it, and demolition removes less than that. For practical purposes the housing a town will live in next year is the housing it lives in today.

The flow is the small part of that stock offered for sale at any moment. It is the flow, not the stock, that sets prices. A town can be full of houses and still have a market in which nothing is available, because the owners of those houses have no reason to move. This is why building statistics and price movements often seem to contradict each other: they describe different quantities.

Flow is also self-reinforcing. Most sellers are also buyers. When people are confident of finding somewhere to go, they list; when they are not, they stay, which reduces what is available, which makes the next household less confident of finding somewhere to go.

Turnover and what “balanced” means

Turnover is the share of the stock that transacts in a year. In most settled places it is low, and in places with high ownership and low mobility it is lower still. Low turnover means the observable evidence about value in any given month is thin — perhaps a handful of comparable sales, none of them exactly comparable.

The usual shorthand for market condition is months of supply: the number of listings divided by the rate at which listings are being absorbed. It is a crude measure and it is sensitive to how listings are counted, but it captures something real. When supply measured this way is short, sellers set terms and buyers compete on conditions as much as on price. When it is long, buyers set terms and the negotiation moves to repairs, timing and contributions.

A market described as balanced is not a market where nothing happens. It is a market where the typical property attracts more than one interested party but not a crowd, and where the gap between asking and agreed price is small and consistent.

Price discovery, one house at a time

In the absence of identical units, price is discovered by comparison and adjustment. A valuation — whether made by a professional, a lender's model or a household with a spreadsheet — takes recent sales of roughly similar properties nearby and adjusts them: more floor area, worse condition, no off-street parking, a busier road. The adjustments are judgements, and the further the subject property sits from the comparable ones, the more of the answer is judgement rather than evidence.

This is why unusual properties are hard to price and often sell either quickly to the one household that wants exactly that, or very slowly after several reductions. It is also why the first few weeks on the market carry so much information: the initial asking price is a hypothesis, and the response to it is the test.

Time on market is a signal, not a wait

Days on market behaves like a price in itself. Interest is highest in the first fortnight, when the property is new to everyone watching. If nothing comes of that period, later viewers see the elapsed time and read it as evidence that others have looked and declined — whether or not that is the reason.

A property that has been listed for a long time therefore faces a worse market than an identical property listed today, which is the mechanical argument for pricing to attract the first cohort of buyers rather than to leave room for negotiation.

Why local markets diverge

Two towns thirty miles apart can move in opposite directions for years. Employment is local: one large employer expanding or closing changes the number of households that must live within commuting distance. Land supply is local: a town ringed by protected watershed, steep slope or another jurisdiction cannot add houses at the edge, and its prices respond to demand more sharply than those of a town with flat, serviced land in every direction.

Regulation is local too. Minimum lot sizes, parking requirements, the cost and speed of permitting, and the rules governing what may be built on a given parcel all determine whether an increase in demand produces more houses or only higher prices for the existing ones.