When discussing real estate, the most popular topic is either what’s happening now in the market or what is coming next. Predicting what will happen is crucially important to both buyers and sellers, yet it remains a very difficult task, despite all of the data we possess.
Real estate markets do shift over time and while it is always clear looking backwards when the shift began, it can be very challenging to identify the shift as it happens. It seems counter-intuitive given the apparent cause and effect when we look back at market shifts of the past. Interest rate changes, a shrinking economy, changing population demographics – when we’re looking back at a market that shifted, it seems obvious that it would happen exactly as it did.
As we work with buyers and sellers, discussions about what is coming next take on huge, practical importance. If you’re looking to buy or sell real estate in the near future, knowing what will happen to supply and demand and how it will impact prices is of great interest.
Let’s look at why it can be very difficult to identify a shifting market as it is happening.
The sale to list price ratio is unreliable
One market stat that gets lots of media attention is the sale to list price ratio. When a home sells for 145% of list price, it is a clear sign that the market is going crazy, right?
The reality is that the sale to list price ratio is unreliable because half of the equation is based on the list price, which can vary tremendously.
- The agent thinks that dramatically underpricing the property increases traffic and the likelihood of more offers, so they list at $999K, despite the neighbour having sold two weeks ago for $1.4M. Buyers and their agents see that good comparable and bid accordingly and the property sells for $1.45M. It sold for 145% of list price.
- A different agent may think that listing a bit below the expected sale price is the better approach and lists the home for $1.3M. Buyers and their agents know about the neighbour selling at $1.4M and decide this home must be significant better and it sells for $1.49M. That’s about 115% of list price, even though the sale price is higher.
- A third agent decides buyers are sick of not knowing what price is expected the best approach is to list the home for sale for $1.49M, with offers anytime. A buyer and their agent see the neighbour sold recently for $1.4M but know that the seller wants closer to $1.49M and makes a successful offer for $1.475M. That means it sold for about 99% of list price.
Whenever we use the sale to list price ratio or even just the actual dollars over list price, it cannot be relied upon as an indicator of what is going on in the market for prices. The sale price is what truly matters, not how much under or over list price.
Averages can be skewed by outliers
While it would seem obvious that using sale prices as indicators that the market is shifting, the truth is that we run into issues here as well, due to the common use of average prices in market data.
The average is simply the result of taking the sum of all of the sales in a market and dividing by the number of sales. While this has the appearance of allowing us to compare apples to apples over time and to see what is changing, the reality is that any outliers (numbers significantly below or above the average) will skew the average. Here’s an example:
- We have five condos that sold in a particular building in each of the last two months.
- Two months ago, there were five one-bedroom units sold and the average price was $652,000. They were all fundamentally similar and we can reliably say that was the cost for a one-bedroom unit in this particular building.
- Last month we had four one-bedroom units sold and we also had one two-bedroom plus den penthouse unit. The average sale price for the four one-bedroom units was $676,000, so if we compared that to the prior month’s $652,000 price, we could see the market is shifting a bit, with prices rising.
- The challenge is that most analyses don’t use just those similar units, but all sales. When we add in the higher priced outlier penthouse unit which sold for $985,000, the average for the building is now $737,800.
- By using the average of all sales in both months, we get an increase of 13% in sale price for the building in a one month period. If we removed the outlier, the actual price increase is about 3%.
Almost all of the market data that headlines are based upon use averages and outliers can and do dramatically impact the resulting analysis. While the data becomes less reliable, it can be equally challenging if statisticians start removing outliers.
If 9 properties are fundamentally the same and one is significantly different, it seems obvious to remove that outlier. In many cases, however, we have small, perhaps significant or perhaps insignificant, differences between properties. With each property removed as an outlier, the question becomes where do you draw the line? Should we remove the penthouse unit in the example above? What if we had a couple of one-bedroom with den units that sold in another month? At a certain point, we’re no longer looking at the market in general, but a specific sub-market, which can pose its own challenges.
It’s not the market overall, it’s your market that matters
While removing outliers in the form of properties that are uncommon in your market can seem to be the solution, the more you do so, the more the data may become unreliable.
This leads to the most crucial challenge in knowing if a market is shifting – the simple fact that the data about the market as a whole may not necessarily be reflective of the market you care about. Let’s consider a few examples.
- If you’re interested in a townhouse in Oakville, where the average price is about $1.6M, how does knowing that the GTA average price has gone up 3.8% last month help? You care about a specific market (Oakville), a specific housing type (freehold townhouses) and a specific price range ($1.5M to $1.7M). Market conditions as a whole are often not reflective of the conditions within a given sub-market.
- When you’re only interested in a specific neighbourhood in Richmond Hill where there are only detached or semi-detached homes, the average price for condominium apartments in Toronto is mostly irrelevant to you. A change in one market may have some minor impact on the market you’re looking in, but the data you want has to do with what’s changing for your community.
There are countless examples that show you need specific data that is relevant to the market you’re focused upon. The more specific the focus, the more relevant the data will be, but at the same time, a smaller number of transactions can make the data less reliable. It often means that it is a challenge for your agent to be able to provide insight into your market that you can rely upon to make a decision to buy or sell.
When trying to assess the state of the market, it is difficult to make sure you use reliable data. If you focus upon sale to list price ratios, average sale prices or overall market data, you can draw false conclusions that steer you in the wrong direction.
The good news is that despite the challenges in assessing your market, there are ways to know what is happening and what is coming next. The use of current (as in the past few weeks not past few months) median sale prices in your specific market as well as related nearby larger markets can allow an experienced real estate agent to give you insight as to what is happening and where your market is headed. If you’re looking to buy or sell real estate, we’d love to help make sure you know what’s coming next. Get in touch with us to talk about your specific market!