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Highlights:

• Author contends Denver housing market is sick.
• Low inventory driving up prices.
• Expects home prices to drop this year.

By Michael Clarkson

Special to InsideRealEstateNews.com

 

Despite all of the recent hype, the Denver-area housing market is not strong.

My research shows that the Denver market is headed for another mini-bubble.

It is true that by the traditional benchmark of months of inventory, the Denver market is looking good.

For the uninitiated in real estate, the inventory is a ratio that is calculated by dividing the “number of homes sold per month” into that number of “active listings.”

Based on that measure, there is only about a two-months supply of unsold homes on the market.

A balanced market is considered to be six months of inventory. Anything above that is a seller’s market, and anything below it is a buyer’s market. Using just this one metric, the Denver market clearly would be “off to the races.” However, there is more to this than just one simple number.

The Denver market is very sick.

Like Lyle Alzado, the former Denver Bronco from the “Orange Crush” era in the 1970s, who died from a brain tumor, the housing market has an outward appearance of health while having a slowly metastasizing cancer lurking in the background – one which could surprise many very quickly.

The Denver market’s strength is not that of a typical market. The market has fewer and fewer listings.

Indeed, there were only 6,786 active listings at the end of February, the lowest in more than 28 years, even though even though Denver metropolitan statistical area grew about  200 percent between 1984 and today. To put that into perspective, Denver typically has 24,400 listings in February.

So, the numerator in the equation (listings) has dropped 72 percent, while the denominator (number of sold listings) is only down by 4.2 percent.

Thus, the relative improvement in the market is an arithmetic function, due to low listing inventory, rather than an actual improvement in the market.

The real problem in Denver is the absence of entry-level inventory.

While it’s true that low interest rates make more expensive homes more affordable, the entry (or re-entry) buyers may tend to be reluctant to sign up for a $250,000 to $300,000 commitment right out of the gate – particularly in such a serial-catastrophe driven economy.

In this environment, one starts to see a phenomenon I call “draining the tub”.

In a normal market, one sees the average buyer acquiring a home that is about 50 percent more than their current home, leveraging the equity built up. Thus, one sees steady growth as inventory cycles.

In today’s market there isn’t much equity.

While about one third of homes are owned outright, the more mobile segments of the market are underwater (or underwater including transaction costs) and unable to move. So, normal supply and demand is disrupted, like is happening in Denver (among other markets).

Here’s where the misconception about market strength occurs.

As upwardly mobile consumers buy homes,  they traditionally move up into more expensive homes.  In a normal market, new entrants come in at the bottom and a sustained growth rate occurs, such as between January 2006 and January 2007.

However, when there are spikes in values like is occurring in Phoenix, Las Vegas and Denver, there is likely one culprit —  the sales funnel is drying up.

The real estate market is like a funnel, or a bathtub drain. When the tub is full or the faucet is on, the tub drains at some rate. Ideally, that drain rate is about the same as it fills up.

When we have a market like we did in 2008, the tub overflows. However, when lower priced activity dries up, as is happening in Denver today, then it’s the equivalent of the faucet being turned off. That’s because few entrants are coming into the market.

When you are looking at the drain, in this case the homes on the MLS, the pipe still looks full – for quite a while after the faucet is shut off. When the tub’s level recedes to the lip of the drain, the pipe still looks full.

However, when the last of the water (listings, if you will) pass into the pipe, nothing flows through the pipeline.

So, how do you tell if the tub is getting close to draining?

It’s really simple: one sees a price spike for listings concurrent with a price drop on actual solds.

At some point that pipeline of sales dries up and sales and prices plummet.

You can see blips in Denver’s market in July 2007, late 2008…and now.

The chart below illustrates what happens when there are 15 homes of different prices on the market. Each month, the least expensive homes sell, until only the most expensive homes remain.

Listings	Month 1	Month 2	Month 3
$100,000	5	0	0
$200,000	5	5	0
$300,000	5	5	5
Total Listings	15	5	5
Average List Price	$200.000	10	$300,000
Average Price Sold	NA	$250,000	$200,000

As you can see,  the more expensive properties list in greater quantity and remain unsold. The fewer, actually affordable listings, transact at a lower volume

This will result in a price drop.

Why?

Well, because using FHA standards (and putting aside PMI and the initial down), a home owner will need to make $100,000 per year to qualify for a $350,000 property – the next rung on this property ladder. Only about 15 percent of the US population earns $100,000 or more per year.

So, when the pipeline of less expensive listings dries up, the market becomes inaccessible (equity excluded) to 85 percent of the US population. A

This causes the median price to drop as listing prices go up. This gives you the divergence you see now in Denver…and saw in July 2007 and in late 2008, resulting in:

• Increasing listing prices.
• Decreasing median sold prices.

What does this mean?

If history of prices repeats – which it often does – Denver will see a drop in prices in 2013. And so will other parts of the country with a similar pattern.

Michael Clarkson is the broker/owner of Snow Coast Real Estate. To learn more, please visit: www.SnowCoastRealEstateBlog.com  or www.SnowCoastRealEstate.com

Have a story idea or real estate tip? Contact John Rebchook at  JRCHOOK@gmail.com. InsideRealEstateNews.com is sponsored by Universal Lending, Land Title Guarantee and 8z Real Estate. To read more articles by John Rebchook, subscribe to the Colorado Real Estate Journal

 

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