When analyzing real estate home sales it is common to see a review of Month’s of Inventory. Simply put, the number of properties on the market divided by the monthly home sales. The concept is a carry over from manufacturing business and helps to determine optimal production levels so that a manufacturer can maximize operations.

The model does not sit well when compared to real estate, however. In the real estate market there are two items that cause the model to fail. First, brokers selling real estate have very little control over the pricing of properties. The price must be agreed to along with a seller. It is not uncommon for a seller to price the property above the market and essentially price it beyond the current market. In almost any property search, there will be a few properties that are priced at two or three times the going rate for the area. These properties would be included in an analysis of months of inventory but realistically are not truly on the market as no reasonable person would be likely to buy them. The results will skew the months of inventory longer than it should be.

The second problem that affects this calculation is the so-called “shadow market” of properties. These refer to properties with owners who would like to sell but who are waiting for property values to increase. They are not publicly listed on the market but have sellers who are willing to sell. These properties would not be counted in a months of inventory calculation as there is no way to determine how many of these properties exist.

When analyzing real estate it is probably better to look at the number of closed transactions and average price per square foot. These two factors can give you a sense of the demand in the market and the price that buyers are willing to pay. While months of inventory will continue to be quoted in the new media and is very common despite these flaws.