Falling inventories are hitting the brakes

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Nationally, inventory is no longer in a free fall, reported Trulia’s Chief Economist Jed Kolko yesterday. The seasonally adjusted quarter-over-quarter change in inventory is negative, but no longer falling as sharply as it did a few months ago. (Year-over-year changes are slower to show a turnaround because they combine a full year’s worth of changes in a single measure. But looking at quarterly or monthly changes requires a seasonal adjustment because inventory has a strong seasonal pattern that makes the underlying trend hard to see.)

The quarter-over-quarter decline in inventory has been at a 14-21 percent annualized rate since October 2012, compared with a 23-29% annualized rate from March 2012 to September 2012:

Nationally, inventory fell 23 percent year-over-year in February, according to the Department of Numbers HousingTracker. Inventory fell year-over-year in all 50-plus markets they track, and by more than 50 percent in several California metros. Price increases and disappearing inventory go hand-in-hand: nearly all metros with the biggest inventory declines also had year-over-year price increases of 10 percent or more, such as Sacramento, San Jose, and Seattle.

Kolko said less inventory leads to higher prices, which in turn lead to less inventory - at least in the short term. Everyone wants to buy at the bottom; no one wants to sell at the bottom. When prices start to rise, buyers get impatient while many would-be sellers want to hold out in the hopes of selling later at a higher price. However, the “inventory spiral” can’t go on forever because eventually rising prices will encourage homeowners to sell and builders to build, which add to inventory and breaks the spiral.

“The critical question for the housing market - especially for buyers fighting over tight inventories - is how long until that kicks in? How long do prices have to rise before sellers and builders start adding to inventory?” asked Kolko.

In the long term, higher prices lead to more inventory -. As prices keep rising, more homeowners decide it’s worthwhile to sell, especially those who get back above water, which adds to inventory. Also, builders take rising prices as a cue to rev up construction activity, which also adds to inventory.

For the U.S. overall, an inventory turnaround in 2013 is unlikely. Since national asking home prices bottomed in February 2012, it may be at least another year before national inventory starts expanding. Inventory will make a turnaround first where asking prices bottomed earliest, such as in Phoenix, Miami, Detroit, Houston, and Oklahoma City. The inventory turnaround is a longer way off in metros where prices have bottomed more recently, such as in Sacramento and the Inland Empire.