42. What are the best predictors of home prices?

People ask me this all the time, and the honest answer is that it depends on how far out you’re looking. The things that drive prices over a decade aren’t the things that tell you what happens next spring.

Over the long term: jobs versus supply

Over five or ten years, it’s pretty basic. Prices follow jobs and incomes, and they get held back by how much housing a market lets itself build.

Metros that permit a lot of homes tend to see slower price growth over a decade, while metros that don’t, don’t. Rates and household formation matter too, but jobs versus supply is most of the story.

Over the short term: watch inventory

Looking forward six to twelve months, I watch inventory more than anything.

Months of supply tells you who has the leverage right now, buyers or sellers. Under roughly four months, sellers have it and prices go up. Above six, buyers take over and prices flatten out or start to slip. That said, every metro is different, a market in equilibrium could be 4-months in one metro and 6 in another so don’t trust the “national” number.

Three other things I keep an eye on:

Affordability. I look at the ratio of payment-to-income in a market. It won’t tell you when prices move, but it will tell you where they’re vulnerable and how far they could fall;

Unemployment. Income growth fixes affordability, but slowly. What I’m really watching for is a jump in job losses. That’s what turns a soft market into a falling one: people who lose jobs stop being buyers, and some become forced sellers; and

Mortgage rates. A one-point move in mortgage rates changes the monthly payment by roughly 10 percent, so it changes what buyers can afford. However, lower rates don’t automatically mean higher prices. If more homes hit the market at the same time, a lot of that new demand just gets absorbed. One example would be owners who’ve been sitting on 3% loans finally deciding to sell.

The bottom line

If I could only have one number to analyze, it would be inventory levels versus the historic norm. Everything else tells you about pressure building up, but inventory tells you which way it’s breaking.