Southern California existing home sales declined to a six-year low for the month of December, according to real estate data firm, DataQuick. Nationwide numbers are equally dismal, with November marking the first year-over-year decline in 29 months, according to the National Association of Realtors (NAR).

There are a couple ways of interpreting this news. We like what Bill McBride of housing and economics blog, Calculated Risk, has to say:

“It is important to recognize that declining existing home sales is NOT a negative indicator for the housing recovery.  The reason for the decline in overall existing home sales is fewer distressed sales and less investor buying. Those are positive trends!”


Mr. McBride has it right: home sales are declining in the face of a speculator slowdown and hobbling end user demand. Buyer purchasing power (BPP) remains severely negative as interest rates continue to rise in the new year. Eventually, this is going to put downward pressure on prices, although California’s metro region is still suffering from 20% year-over-year price inflation.

Not everyone gets this very important picture of demand in the real estate marketplace. NAR still wants agents to believe the main culprit stifling home sales is tight supply. So says NAR’s chief dogmatist, Lawrence Yun.

What the trade association has missed is that supply is always a function of demand — it does not sway the market one way or another as an isolated factor. In other words, the phrase, “tight supply” only has meaning relative to the demand existing for that supply, which remains weak in today’s market.

The folly in supply-side thinking is that it leads to over-correction; in this case, it implies building is the answer. In a market hampered by rising interest rates, stagnant wages and tight credit, ramping up production is a risky endeavor for builders. Right now construction starts are up since end users tired of competing with speculators are buying new properties. Once the market returns to normal and speculators go looking for another investment, there will be insufficient demand to satisfy the new inventory.

This reality, though stark, will not be disastrous. The rise in starts is nowhere near the levels we saw during the Millennium Boom and builders are suffering from tight credit as well, which has kept animal spirits at bay.

Speculators are splitting and equity is balancing out, which means the total stock of existing homes available for sale will naturally increase over 2014. Don’t sweat the inventory right now. As we’ve said before and respectfully say again, it’s the demand, stupid.

For a detailed analysis of California’s flagging home sales volume, see our recent article, “December home sales volume lowest since 2007“.