Persistence of market conditions in real estate markets

We show how using commonly reported measures of real estate market conditions can improve the accuracy of price predictions. The standard model of competitive markets asserts that excess demand causes price(s) to adjust to an equilibrium with little delay. In an illiquid market, such as the market for real estate, attaining an equilibrium may take significantly more time. That fact implies that data on market conditions would be informative. A better understanding of the adjustment process in a real estate market could also lead to buying or selling strategies which are better informed.This paper has two parts. The first part uses different types of models to focus on the conceptual distinction between an exogenous variable and an endogenous variable. Based on this distinction, we offer six hypotheses on why the effects of marketconditions might differ between cities. The second part uses vector auto-regression to study the persistence of several variables, with a particular focus on an inflation-adjusted price index and two popular measures of excess demand (the ratio of sales to new listings and “Months of Inventory”). Using monthly data on residential real estate markets in 31 Canadian cities, we find that excess demand affects prices contemporaneously, that changes in measured excess demand persist for a significant period of time and that they affect prices with a lag. We also find evidence of a statistically significant feedback effect, in some cities, from changes in prices to the measures of excess demand.