A raging debate has been taking place concerning the health of real estate, and how long it will take to absorb the excess supply. Here is a probable scenario (data thanks to Century Management):
In September 2010, there were 3,585,000 homes listed for sale. At the current average rate of 350,000 homes being sold per month (annualized, seasonally adjusted, as of September 2010), it will take about 10 months to go through the inventory currently on the market.
The historically normal inventory is 4.5 months. That means we now have 5.5 months of excess inventory that needs to be sold in order to return to a normal real estate market. That's roughly two million units. So if no new inventory is added, and with an average of 350,000 homes sold per month, it would take 5.5 months to absorb this inventory.
However, that calculation leaves out the "shadow inventory". According to CoreLogic®, 3,776,420 out of the 47,802,783 outstanding mortgages are in default (REO plus 90 days past due), or 7.9% of the total.
Assuming that 50% of that shadow inventory gets foreclosed and these homes enter the
market (the foreclosing banks will be willing sellers), and assuming the default rates continue at this level for the next four years, it would take less than two years to absorb it all:
3,776,420x 50%= 1,888,210
1,888,210 : 350,000 monthly sales= 5.4 months
5.4x4= 21.6 months
Less than six months to work off excess inventory, plus 21 months if you include shadow inventory, comes to a little more than two years, and puts us in 2013. That does not seem so bad.
What's more, the market corroborates this assessment. It is not a coincidence that many housing related stocks are moving higher recently: Sherwin Williams (paints), Pier 1 Imports and Williams Sonoma (home furnishing), Black & Decker (tools) Home Depot and Lowe's (home improvement), among others.
Stocks are forward looking, and these stocks are going higher because the customers are back. People wouldn't be spending money on their homes if their values weren't going higher, and that sentiment is the beginning of good news for real estate nation-wide.
Alan Schram is the Managing Partner of Wellcap Partners, a Los Angeles based investment firm. Email at email@example.com.