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Last month we talked a little about some trends we are seeing in the different capital cities of Australia. These were all based on changing inventory levels. But what exactly are ‘inventory levels’ and why do they matter to an investor?
Blogger: Greg Dickason, general manager, data products at RP Data.
To an economist, inventory levels are the quantity of goods available to meet a particular market need. The goods do not have to be the same as long as they can be substitutes for each other. A good example is bananas and mandarins, I will choose to buy mandarins instead of bananas if mandarins are cheaper. My need is to provide my family with a healthy fruit snack and I will substitute mandarins for bananas as a result.
To an investor in housing, inventory is the stock in the market you are competing in. Specifically, the stock that your ‘buyers’ may substitute with your product. Examples could be:
- For an investor renting out a property, both:
- How many other rentals are listed that a potential tenant could choose instead of your property, and
- How many properties for sale that a potential tenant might choose to buy instead of renting your property
- For a small-scale developer building units on blocks of land for sale, the quantity of other new units and other ‘substitute stock’ like older units and small houses also for sale
Once you have an idea of the inventory levels you are interested in, what is their importance?
Simple: Inventory trends tend to predict price trends in a market. If total inventory is trending up (supply is exceeding demand), then in the medium term price will decrease. Similarly if inventory is trending down then price will increase to limit demand and balance the lower supply.
As an investor you are selling products to the market, and therefore the price of your product should interest you. The product may be ‘a roof over someone’s head’ and you want to track what the inventory levels for these products are:
- Number of properties for rent in the price range, for the areas tenants would consider
- Number of properties for sale where the mortgage repayments and incentives (like the first home owners grant) offer a substitute product to tenants
Using a tool such as RP Data’s RP Professional you can track both of these inventory levels and over time provide an indication of the trends. By adding in other predictors such as the total number of properties purchased by investors (which will in future become properties advertised for rent), you will get an accurate idea of what is happening in underlying market trends and the impact on vacancy rates.
Similarly, if you are a small lot developer; tracking the number of small lot development applications, and property sales with attributes for a small lot development (size of land and street frontage) in your area you are able to track the market supply of your ‘primary inventory’. Add in secondary listings of existing units and small houses to give a count of ‘substitute goods’ and you end up with the total inventory trend.
Once you know the trend, your actions in the market can be more informed. In a market where inventory is dropping, prices will eventually rise, so you can plan for this through building more or investing appropriately. In the opposite market, where inventory levels are increasing, locking in tenants or appropriately timing when your new units get onto the market becomes more important.
Hopefully you are better at predicting and managing your future investment success than some economists are at predicting our economy!
Hopefully you are better at predicting and managing your future investment success than some economists are at predicting our economy!
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