Thinking About Money

When people talk about a housing bubble, it’s important to distinguish between an oversupply of houses and an oversupply of real estate agents. I’ve written recently on my belief that, at least on a national basis, there is no housing bubble and that the decline of housing prices that we are seeing (and will continue to see) looks like a typical housing cycle.

Most of the people who talk about the housing bubble base their opinion on anecdotal evidence and not real numbers. So, for example, we hear stories about the tough real estate market, Realtors going without pay for months, and a drop in the number of real estate transactions.

It’s important to distinguish between number of transactions and prices – they are two different things. Number of transactions is a measure of economic activity. It is driven in part by population growth, in part by people who are moving for various reasons, and in part by speculation. Recently we have seen not just a boom in housing prices, but also a boom in the number of transactions.

Prices are driven primarily by supply and demand, which is only partially related to the number of transactions. This can be understood intuitively by considering this simple fact – in most cases a homeowner doesn’t have to sell. While someone might want to upgrade to a nicer home, it’s usually possible to put it off. While someone might want to purchase a home, they can usually keep renting for a while.

Home prices have increased sharply in the past 4 years, but so has the population (underlying demand). As I wrote in “Housing Cycles – This Time With Pictures” We are overdue for a correction, but on a national basis it is much more likely to be in the 20% area – not a crash (remember though, these are national figures – local bubbles almost certainly exist, especially in areas of declining population).

However, that does not mean there is not a bubble. There is – the Realtor bubble.

The following chart shows a dramatic increase in the number of realtors in the past few years.

We haven’t seen a growth like that since 1975. What happened in 1975 is unclear – there was a recession, but it at the same time housing prices were heading up. Clearly real estate became very popular at that time (as I recall, that was a period of a major bust in aerospace – and many former engineers were going into the field). It could be that the increase then was due to demographic shifts (more women entering the workforce), or more agents joining the national association of realtors (whose membership statistics are shown here).

What is clear is that from 1980 until 2002, the ratio between number of existing homes (indicating the potential homes that could be sold) and number of realtors has remained nearly constant even through the 1987-1991 housing cycle.

Since 2002 we have seen not only an increase in prices, but also a dramatic increase in the number of transactions and Realtors.

Here is the key thing to keep in mind:

The income of Realtors (and thus number of Realtors that can be supported) depends primarily on the number of transactions – NOT the price of houses!

I know what you’re thinking – that if housing prices go up more realtors can be supported because each one needs fewer sales. There is a small amount of truth to that, but not as much as you might think – because this is offset by inflation. The appreciation of homes is only slightly above the inflation rate (in the long term), so the impact of an increase in housing prices is small compared to the impact of the number of transactions.

Conclusion:

As you hear stories about dropping housing prices nationwide or in your area, keep your eye on the median home price. That’s the number that discusses housing prices in your area. Panicky reports on the number of transactions are more likely to reflect panic on the part of real estate agents, mortgage brokers, and others whose livelihood depends on transactions.

As for the Realtor bubble? It’s hard to say, but to return to historical levels; it wouldn’t surprise me if there are 30%-40% too many Realtors for a normal down cycle.

Sources:

• Housing inventory: http://www.census.gov/hhes/www/housing/hvs/historic/histtab7.html
• Transactions: http://www.realtor.org/Research.nsf/files/REL0605EHS.pdf/$FILE/REL0605EHS.pdf
  http://www.huduser.org/periodicals/USHMC/spring03/histdat07.htm
• Realtors: http://www.realtor.org/libweb.nsf/pages/fg003

This entry was posted on Sunday, July 9th, 2006 at 12:35 pm and is filed under Real Estate. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.