Buyer's vs. Seller's Market
We often hear realtors talk about buyer’s and seller’s markets when referring to market activity, but what are they really talking about? Today we are going to break down these two commonly heard real estate terms.
To begin, the attribute of the market (buyer or seller) refers to who it benefits. A buyer’s market benefits buyers, and a seller’s market benefits sellers. So let’s break it down more.
Understanding Inventory Levels.
Buyer’s and seller’s markets are determined by inventory levels (inventory just refers to the number of homes for sale in an area). In real estate, a formula called the absorption rate is used to detect the rate at which homes are selling. A low absorption rate means homes are sitting on the market, and a high absorption rate means they are selling quickly. The absorption rate equals the number of properties pending sale divided by the number of available (or active) properties and is expressed as a percentage.
Absorption Rate (%) = Pending Properties / Available Properties
This formula can be reversed to find the Months of Supply Inventory (MSI) – often expressed as “months of inventory” – which refers to how many months it would take for the current supply to sell at the current rate of sales. So the formula for inventory would be:
Months of Supply Inventory = Available Properties / Pending Properties
If you hear a realtor say “we have 1 month worth of inventory,” they are using this formula and suggesting that there is one month worth of supply in the market. See the examples below.
Example 1: If we have 1,000 active properties and 500 pending properties, then we have 2 months worth of inventory (1,000/500). The absorption rate would be 50% (500/1,000).
Example 2: If we have 500 active properties and 1,000 pending properties, then we have 1/2 months worth of inventory (500/1,000). The absorption rate would be 200% (1,000/500).
Example 3: If we have 500 active properties and 500 pending properties, then we have 1 month worth of inventory. The absorption rate would be 100% (500/500).
Buyer and seller market standards can vary in different areas, but in the Bay Area, a buyer’s market typically occurs when there are 2.5+ months of worth of inventory. A seller’s market occurs when there is 1 month (or less) worth of inventory. The market is considered to be well-balanced at ~1.5 months of inventory. For specific information on your region, speak with a local realtor.
Buyer's Market.
If you are a home buyer, and you hear that your area is experiencing a buyer’s market, that’s a great time for you to get active with your home search. Why? A buyer’s market refers to a period when there is abundant inventory (MSI greater than ~2.5) and a low absorption rate, so buyers have a negotiation advantage.
Think of this example. You are a prospective buyer who is ready to purchase your next home. When you meet with a realtor, they have plenty of homes they can show you that are a good match, and they are confident that they can negotiate the price down. Why are they so confident? Well, when there are a lot of homes for sale, the demand for each individual house reduces, so sellers can’t really push a price that’s higher than the market standard. If they do, you might as well go and look at one of the many other options your realtor found.
Seller's Market.
In a seller’s market, inventory is low but buyers are active (low MSI & high absorption rate). This creates high demand for the few homes for sale, which means most will sell rather quickly and with good terms. Additionally, the properties often get multiple offers, giving the sellers negotiation power. During a buyer’s market, however, a home can sit on the market for weeks with few offers.
So imagine you just listed your home at a competitive price, and within the week, you get 3-4 offers on your home. Each of the bidders tries to distinguish themselves from the competition by presenting more favorable terms (e.g. shorter escrow period, all cash payment, etc.) or a higher offer. When you see these offers, you have the power to choose which one you prefer, or even negotiate for more because the demand is so high.
Remember, even if you are listing your home during a seller’s market, you should not overprice your property. If you do, fewer people will come to view your home, and it will likely sit on the market. When a home sits on the market for a long period of time, buyers sometimes assume it is because there is something wrong with the property. Instead, it’s best to wait until you receive a few offers so that you can see what people are willing to pay, and then you can negotiate better terms or a higher price according to the demand. Even your mother would not want to buy a home from you if it’s clearly overpriced.
How Do I Know When It's A Buyer's/Seller's Market?
If you know the number of active and pending properties in your area, you can use the absorption rate formula to determine where the market is. However, this information is typically not public. Your best resource for the data will be a local real estate agent. The market can vary from city to city, and it can shift quickly. Realtors will have the most up-to-date information on inventory levels for your region, and they can tell you the rate at which homes are selling.
Your knowledge of the market can have a significant impact on your real estate experience. For sellers, this knowledge will help you understand how to best price your home and give you a realistic expectation of how long your home could be on the market. For buyers, understanding the market can give you insight into the level of competition, which will help you identify the best negotiation strategies. However the market is positioned, find a real estate professional you can trust, and stay informed.
