Real Estate Math Helps Forecast Housing Market Moves

If anybody claims to have a scientific method to forecast the future of the real estate market, I have yet to see it. I have devised my own version of "real estate math" in the hopes developing a model that will bring about accurate reports for near and long term expectations for trends in the housing market. I believe I have made some progress, as my blog post in 2008  (click to see 2008 real estate forecast) has done a good job thus far in forecasting home sales in Tallahassee.

Real estate math is just a term that I use to apply the same rudimentary analysis to the real estate market as basic level analysts use in other commodity markets. My primary methodology is to record as many quantifiable metrics as can be identified, so that over time trend changes will emerge to provide us with realistic expectations. So far, I have been pleased with our results.

Real Estate Math Theory

When I published my first long-term forecast in 2008, I included three assumptions that are hard to dispute. For purpose of review, I have listed them below, but for a full explanation, please visit the original article from my 2008 real estate forecast:

1. There is a measurable correlation between home sales and population size.
2. In every commodities market (in this case real estate) buyers fall into one of two categories, discretionary and non-discretionary.
3. Outside influencers make the market imperfect, but the market will always seek to return to “normal,” which is defined as the expected ratio between home sales and population.

When we create a real estate graph to examine home sales in Tallahassee, the visual record of what has transpired is very clear. From 1991 through 2006 we see the housing market climb, but from 2006 to present we see it decline. The addition of colored trend lines in the graph makes the "boom" (market expansion)  very clear. The steady rise in the market that we saw in the 1990s was replaced with a frenzied burst from discretionary home buyers. Apparently, the real estate market was the solution of choice for investment when the stock market (tech bubble) burst in early 2000.

Forecasting With Real Estate Math

In order to use our real estate math to forecast the future movements in the Tallahassee housing market, all we need to do is to establish our "expected" level of home sales and then compare it with the actual number of homes that sold during the same period of time. In the graph below, the red bars show our expected level of home sales (see blog post on correlation between population size and the number of homes that sell each year) while the green bars represent the actual (and forecasted) number of home sales for the same time period.

Remember, the "expected" level of sales is not the forecast, rather it is the amount of sales that would occur in Tallahassee, based upon our population size, if market cycles did not exist. The "delta" in the graph above is simply the measurement of the difference between expected and actual sales, while the "cumulative" is a running total of the delta. The resulting market imbalance shows that the market is ahead of schedule for expected sales, and the market recovery should take several more years to conclude.

The easiest way to visualize the market imbalance is to think about digging a hole in the yard. Every shovel full of dirt creates both a hole, and a mound. The depth of the hole determines the height of the mound, but the totality of the yard does not change. In our real estate math model, when we see a hole, we expect a mound to occur in the future. When we see a mound, then we expect a hole in the future. Currently, we are continuing to work away at the mound that we created during the six-year run of the housing market boom.

At the end of 2010, our model shows the market imbalance at roughly 5,000 homes (which is nearly 11 months of home sales at the "expected" rate of sales). This is a vast improvement from the 11,600 level that was reached by the end of 2007. The Tallahassee housing market will continue to perform below the expected level to consume these 5,000, but most likely will proceed to over-correct as most market cycles changes do.

I believe the Tallahassee housing market will consume all of the market imbalance by the end of 2012 or early in 2013, but the imbalance will then shift in the other direction (meaning home sales will still fall short of the expected level for a few more years). The "outside influencers" are still very active (primarily the banking industry) and that is why our projection of a recovery is further out than what most "industry experts" are advertising.