Using Supply & Demand Indicators to Make Buying Decisions

The price growth of any commodity in a free market is governed by the law of supply and demand.  Investors seeking capital growth are looking for markets with high demand relative to supply.

An oversupplied market is flooded with housing, there are more sellers than buyers, putting downward pressure on prices as desperate owners lower their prices to secure a sale.  In an undersupplied market there are more buyers than sellers, which creates capital growth as sellers set and achieve their price points and buyers pay more to secure properties.

There is one tool in particular useful for recognizing and avoiding oversupplied markets, the Demand Supply Ratio.  This tool takes into consideration a number of statistics all useful for interpreting market conditions and movements:

% Stock on Market
The number of properties for sale relative to the total number of homes in a suburb.  This is a supply indicator and the higher the number the greater the supply.  The lower the number the better, ideally less than 1%, generally anything more than 2% is too high.

Days on Market
The number of days on average that a property is advertised before it is sold.  This is a demand indicator.  The lower the number the better, less days on market means more buyers looking for and securing properties.

% Vendor Discount
The percentage that the original listing price was reduced by to secure a sale.  The lower the number the better.  When demand for property is high and supply is low, sellers won’t discount much because they have something buyers want.

Online Search Interest (OSI)
The number of online searches divided by the number of properties for sale.  A high number indicates more buyers than sellers in the market.

% Renters
The percentage of renters as opposed to owner occupiers.  A low number is generally more favourable as in indicates less competition for vacancies and owner occupiers generally tend to take better care of their own homes and invest more improving their properties which could indicate a better standard of housing.

Gross Rental Yield
Typical rental returns as a percentage of property value.  The higher the number the better the cash flow.  This is also a lead indicator for capital growth, if tenants are attracted to an area and willing to pay more to live there then buyers will usually be following suit but more slowly since it’s easier to move if you’re a renter than it is if you’re an owner occupier.

Vacancy Rate
The % of rental properties currently unoccupied.  The lower the number the better as low vacancy rates indicate demand for rental properties and limit periods of vacancies which are costly for investors.

Auction Clearance Rate
The % of properties that actually sell at auction.  Where there is good demand, there is increased likelihood that properties will sell at auction as buyers push the price up as they bid.  A high number indicates strong demand compared with supply.

All of these inputs are combined to calculate the Demand/Supply Ratio.  This is a score out of 100 that measures demand relative to supply.  A score of 50 is the balance point.  Scores below 50 are considered undesirable because supply exceeds demand at this point.  Scores above 65 are much more desirable because demand exceeds supply.

demand-supply-ratio

Reliable research indicates that markets with a high DSR can be expected to outperform markets with a low DSR.  See the following chart as an example.

dsr-2-year-growth

In this example, if you bought into the market at a DSR of 30, you would have waited much longer to achieve capital growth than if you had entered the market at a DSR of 65.  Markets with a low DSR are easier to buy into, property is cheap and there is a lot on offer, sellers are negotiable on price, it’s a buyer’s market.  Markets with a high DSR are harder to enter, property is more tightly held, there is more competition between buyers and sellers are less likely to discount it’s a seller’s market.

While there are other factors that need to be taken into account when forecasting market performance and making buying decisions, the DSR is a quick calculation that can be used to gauge overall market health.

The Demand Supply Ratio:

  • Gauges growth potential – the is a correlation between DSR and price growth.
  • Is an objective measure – it is calculated by a computer so not subject to human hopes and fears.
  • Is consistent – you can use the same algorithm to make comparisons, thus comparing apples with applies.
  • Is numerical – it’s hard to forecast whether the shopping precinct expansion will have more of an impact on property prices than a new transport link, but a 2.5% vacancy rate is definitely more favourable than a 4% vacancy rate.

So where can you get this information?  A great little website called http://dsrdata.com.au.  It’s free to subscribe to the basic package, you can pay a monthly fee for more indepth statics, or just pay extra for specific data on suburbs you are analysing.

It pays to be diligent and this is just one of the tools available to help you invest smarter.