Rising Home Sales Are Not a Harbinger of Housing Market Recovery

Commentators have been focusing on rising home sales as an indication of health in the Bay Area housing market. But those rising sales have been accompanied by sharply lower prices. Or to put it more accurately, rising sales have been caused by sharply lower prices. Take a look at the chart, below, which provides a schematic picture of what I'm talking about.

Market equilibrium occurs when supply equals demand. This is indicated in the chart by the intersection of the solid blue and purple lines. The supply of for-sale homes has risen significantly over the last year or so, due to heavy sales of bank-owned homes. This is indicated in the chart by the dashed blue line, which sits to the right of the original supply curve.

As long as demand is stable, you can always sell more of your product if you reduce the price. Falling prices do in fact seem to have stimulated demand for homes in the Bay Area, suggesting that demand may be stabilizing. That's better than falling demand, but it's hardly a sign of recovery. A true recovery in the housing market will be marked by rising demand.

How will we know when that happens? In the schematic picture above, rising demand would be indicated by moving the demand curve to the right.

The new equilibrium is marked, not only by higher sales, but by higher prices as well. The picture won't be quite as simple if supply is still rising (then the blue line would move to the right as well), but you get the idea by now. As long as prices are still falling, it will be difficult to argue that the housing market is recovering.