On Thursday of last week, we learned that home prices increased at a faster rate in November than a consensus of analysts and economists had originally forecast. And on Friday, we learned why.
According to the National Association of Realtors, the inventory of existing homes for sale dropped by 11.1% last month to 1.85 million homes. That represents a 4.4-month supply at the current sales pace, which is down from 5.1 months in November.
This matters because any time the supply of listed homes is below six months' worth of sales, the prices of homes rise. Whereas any time the supply equates to more than six months' worth of supply, prices fall.
This is econ 101, right? The price of housing, like any other good, is dictated by the relationship between supply and demand. The higher the supply relative to demand, the lower the price. The higher the demand relative to supply, the higher the price. In this way, price is nothing more than an equalizing force that helps markets, at least in theory, reach a "stable equilibrium" where there's a balance between buyers and sellers.
Given this, the more important question is: What's going on with the supply of listed homes? Why has it been below the six-month threshold for so long? Why haven't the magical market forces, communicated via price, pushed the housing market back into mystical equilibrium?
The answer to this has to do with the amount of equity homeowners have in their homes. According to RealtyTrac's latest "U.S. Home Equity and Underwater Report," an estimated 7.1 million residential properties are "seriously underwater," meaning that their value is at least 25% less than the mortgage. And according to CoreLogic's most recent "Equity Report," an additional 9.4 million homes have positive equity but are considered "under-equitied" -- meaning they have less than 20% equity.
This is a problem because the sale of an underwater or under-equitied home potentially forces its owner to realize a loss. Anyone who's sold an asset for less than they paid for it knows how this feels and can thus understand why so many homeowners aren't inclined to do so.
The net result is that the price of existing homes must, almost by definition, and barring unforeseen developments, continue to rise in 2015. As this happens, more homeowners will recover more equity, which, in turn, should free them up to list their homes. But until that happens, it's bound to be a seller's market (though, of course, ultra-low interest rates should bring plenty of buyers to the market as well -- but that's for another day).