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 The price of housing, like all goods and services, is a function of supply and demand forces. Hence, in thinking about the direction of house prices over time, supply, or inventory, plays a critical role. When the inventory of homes decreases, prices tend to increase because buyers are competing for a smaller number of available homes. Similarly, increasing inventory pushes prices lower.
The supply of housing is usually reported in one of two ways: "Inventory" and "Months of supply". These numbers are reported by The National Association of Realtors (NAR) for existing homes and the Census Bureau for new homes. Inventory is the total number of units available for sale. Months of supply is equal to inventory/seasonally-adjusted monthly sales rate. Months of supply can be interpreted as the number of months necessary for all of the existing inventory to be sold.
Level of supply is driven mainly by sellers' interest in selling at a given time, but is also a function of demand for housing. Because the mortgage lending practices are now tighter, effective demand for housing has shrunk, contributing to the glut of houses available. It's important to note the distinction between 1) the level of supply (is it large or small), 2) the trend of supply (is it increasing or decreasing), and 3) the rate of the trend/direction (is the movement accelerating, or leveling off).
Months of Supply
Months of supply is a useful measure that describes the amount of time required to sell through the current # of houses for sale on a market. When months of supply is high (greater than 6-8 months), house prices start to decrease. Frequently in situations where supply is high, the months of supply statistic is often underreported, because it does not take into account houses that have been removed, unsold, from the market. Also, there is always a time lag in reported months of supply - usually of approximately two months. Hence, if there is an increasing supply trend, the latest data is likely understating the actual, current supply environment.
Buyers Perspective
When months-of-supply are at high levels, you are approaching a seller who may have few, if any, competing offers on the house. It may be possible to ask for and receive concessions from the seller, such as reduced price, better financing, or even some 'goodies' such as a hot tub or plasma TV. If conditions are suggesting that inventory is increasing, it may be worth waiting until inventory has at least leveled off at close to the peak, because it's likely that prices will continue to fall in conditions of increasing inventory.
Sellers Perspective
When months-of-supply are at high levels, it can be difficult to attract potential buyers. It's important to ensure that the house is priced accurately at market levels, and may need to be priced lower, to increase chances of selling, and selling quickly. Additional perks can be added to the house to 'sweeten' the deal.
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