Within an MSA, there are often submarkets where careful risk/reward analysis says you should:
- buy land and build more homes in one submarket
- sell your land holdings in another submarket, and
- be more aggressive with price appreciation assumptions in a third submarket.
When identifying new opportunities, multiple metrics are needed to understand the entire picture of a submarket’s health. Existing home activity can shed considerable light on market dynamics. Some of our favorites are:
- resale volume
- existing home turnover ratio
- distressed sales as a % of total sales
- change in median sales prices, and
- distressed sales volumes
Let’s look at the Washington Metro Area as an example.
1. Resale volumes. Existing home sales trends are an excellent predictor of new home demand, but this metric alone may not tell the whole story. Consider existing home sales volume in the DC submarkets shown on the graph below. At first glance, it looks like Fairfax County and Montgomery County are the submarkets with the most opportunity based on their high sales volume.
High volume markets are tempting but, as the following charts demonstrate, they have varying degrees of risk and reward.
2. Ratio of existing home sales to owner-occupied housing. If you also consider housing turnover —existing home sales as a share of owner-occupied homes— by submarket, the story changes. It is now clear that housing demand was strongest in the city of Alexandria, which offers potential for infill development and in Loudoun County, which offers potential for suburban development. And, although its sales volume was the highest in the region last year, turnover in Fairfax County was below the regional average.
Is low turnover due to a lack of supply or a lack of demand? This likely differs by submarket. Introducing a well-positioned product in a healthy market could unlock unmet demand.
3. Ratio of distressed sales to total sales. Prince George’s County leads the region with the highest share of distressed existing home sales followed by Frederick County, MD and Prince William County, VA.
Resist the natural avoidance of distressed markets. If you have appetite for risk, dig into the data to uncover the opportunities in the C and D submarkets.
4. Median existing home sales prices. Not surprisingly, the three counties with the highest share of distressed sales also posted the lowest median sales prices in the region in 2013.
Is this yet another reason to avoid these counties? Perhaps not as this is the law of supply and demand at work. Many home shoppers will be drawn to affordable markets which then leads to increasing prices.
5. Ratio of median sales price gains to distressed sales. Consider that the three markets that lead the region with the lowest median sales prices and the highest share of distressed sales also lead the region in year-over-year median sales price increases. This indicates that the distressed sales’ negative impact on prices may be waning and presents an opportunity for builders in these markets to see price gains faster than elsewhere in the region.
Your decision to operate in a particular market needs to be based on your requirements for yield, sales volume and your appetite for risk. Struggling markets may have a potential positive upside and should not be ruled out entirely.
A particular submarket’s potential may not be obvious from a cursory view of the data. Instead, use all the tools available to expose market opportunities that might have otherwise been missed.
- Buy Land and Build More Homes. High turnover indicates a market whose residents are ready and willing to move (such as Alexandria and Loudoun County in our example). Give them a good reason to make that decision with targeted product based on solid consumer research and competitive assessment.
- Sell Your Best Land. Land prices in great locations can become irrational, in which case we advocate the “Buy Low; Sell High” strategy.
- Bet on Price Appreciation. Consider that C and D locations known for low prices and a recent history of unusually high distressed properties may also have the largest potential for price appreciation going forward (Prince William and Prince George’s counties here). As the supply of distressed properties shrinks, the demand for new but affordable first-time and first move-up product will increase.