Sales and Must-Sell Inventory

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I speculated in an earlier entry that measuring monthly home sales against monthly notices of default would provide a fairly good read on the health of the housing market.

This idea is borne of the observation that excessive inventory does not by itself put much downward pressure on home prices. As long as sellers can hold out for higher prices, they can be depended upon to sit tight and do just that. Prices don't fall substantially until too many motivated sellers -- those who are forced for one reason or another to sell at whatever prices they can get -- enter the market.

But how many motivated sellers is "too many?" That's where the sales volume comes in. If must-sell properties account for just a small number of the homes being sold, the must-sellers are unlikely to have much effect on aggregate prices. But if enough transactions involve highly motivated sellers, prices could suffer.

Notices of default -- otherwise known as NODs, or the nastygrams that mortgage lenders send to delinquent borrowers -- can serve as an indicator of how much must-sell inventory is out there. It's a rough indicator, mind you. Plenty of defaulting homeowners end up working out their loans, even as some desperate sellers (whose motivation may stem from job loss, relocation, or divorce) enter the market without ever having incurred an NOD. While not a precise measurement, however, the number of NODs delivered in a given month likely correlates very well with the amount of must-sell inventory on the market.

As for measuring demand, a monthly tally of single family home sales does the job nicely as long as we keep in mind that we are comparing single family home sales to all NODs, regardless of defaulted property type. I mention this distinction to avoid confusion, not because of analytical import. The actual ratio is not what we are after here. We are concerned about trend changes in housing demand versus must-sell supply, and dividing single family home sales by notices of defaults is about as close as I've been able to get.

With all that said, let's have a look at the accompanying chart. It displays the number of single family home sales divided by the number of NODs occurring in each month going back to January 1988. Single family home prices, as measured by the Case-Shiller San Diego Home Price Index, are included as well.

The red sales-per-default line clearly serves as a leading indicator, peaking or troughing well before a corresponding change in price levels. It's also interesting to note that a sales-per-default figure of "2" seems to be the magic number here: for the most part, prices have risen when the sales-per-default ratio was above 2 and falling when the ratio was below 2.

It should be no big surprise, given recent writings here, that February was one of the worst months on record for this indicator. It will be interesting to see what it tells us in the months ahead.

-- RICH TOSCANO