Image: Housing construction
Paul Sakuma  /  AP file
Workers build a new home in Palo Alto, Calif., recently. Home builder sentiment is at its lowest level since such surveys began 20 years ago.
By John W. Schoen Senior producer
updated 7/24/2008 11:12:10 AM ET 2008-07-24T15:12:10

When will home prices stop falling?

The answer is critical to millions of American homeowners who are watching their home equity melt away or are unable to move because falling values have sent potential buyers to the sidelines. Even if you don’t own a home, the question is central to your chance of getting a good night’s sleep if you’re worried about your job, your bank account or the investment in your 401(k).

In the latest evidence that prices are still sliding, the National Association of Realtors reported Thursday that the median price of existing homes sold in June fell to $215,000, down 6.1 percent from a year ago. Sales fell 2.6 percent from the month before — far more than analysts had expected.

Richard Gaylord, president of the Realtors, said a recent survey found that nearly one-quarter of potential home buyers are "waiting on the sidelines." A major housing package passed by the House Wednesday after months of debate could help boost the market by offering a credit to first-time home buyers, the group said.

But forecasting a turnaround in any financial market is a tricky business. And the current housing market is vulnerable to a variety of unique variables that make calling the bottom even tougher.

For starters, a lot depends on whether anything can be done to stop the ongoing wave of home foreclosures. As the inventory of bank-owned properties keeps rising, lenders have become eager sellers, hoping to get those properties off their books before prices fall further. For the same reason, potential buyers are either waiting on the sidelines or making fire-sale bids. A surplus of motivated sellers and a dearth of interested buyers is pretty much the formula for further prices declines.

With mortgage delinquencies rising, more foreclosures are on the way. The question is, how many? Some of those at risk of losing their homes got in over their heads or were sold loans they couldn’t afford. As the economy has worsened, households that might otherwise have held on are succumbing to job loss or rising food and energy prices that are busting their monthly budgets.

Congress this week finally passed a major housing bill after nearly a year of debate, but the measure is expected to help relatively few borrowers. The bill extends government backing and oversight to mortgage finance giants Freddie Mac and Fannie Mae to keep the mortgage market functioning, but that will do little to help existing homeowners at risk of default.

Then there’s the question of oversupply. As the housing market ground to a halt over the past year, homebuilders continued to build, hoping that the downturn would be short-lived. As a result, the inventory of unsold homes rose well beyond what was needed to meet demand. Until demand picks up, that surplus will continue to weigh on prices.

Despite rising foreclosures and skittish buyers, housing demand continues to grow every year through the creation of new households, whether from children moving out on their own, new couples getting together or couples splitting up. With current level of 111 million U.S. households growing by about 1 percent a year, new households will absorb about 1.1 million housing units a year, according to RDQ Economist chief economist John Ryding. That’s just about how much surplus housing is on the market. So even if new construction ground to a halt, it would take a while to work off that backlog.

“Bottom line, we probably have a year or more to go to grow into a better balance in the housing market,” said Ryding.

Major Market Indices

Home builders are still building, although housing starts for single-family homes fell another 5.3 percent in June to a 17-year low. Construction levels will likely continue to fall from current levels, according to Merrill Lynch economist David Rosenberg. He estimates that the excess inventory of new homes is nearly 30 percent higher than levels historically seen for a trough in housing starts.

“We may have to see as much as a further 30 percent decline (in housing starts) from here,” Rosenberg in a research note.

All of which has home builders feeling gloomier than at any time since their trade group began tracking sentiment 20 years ago. The National Association of Home Builders index fell in July to a record low of 16; a reading above 50 means builders are upbeat about the outlook.

Even if all the bad loans could be cleared out to the system quickly, and excess inventory of new homes were cut to more normal levels, housing prices still have to come down from the irrationally exuberant levels reached during the height of the housing bubble.

There are several ways to measure just how far prices have fallen so far, although each has its shortcomings.

The Realtors' monthly data on existing-home sales, which shows the median price down 6.1 percent in June from a year ago, only measures buying patterns for homes sold in a given month, which may not be comparable from year to year.

OFHEO, the federal regulator overseeing mortgage finance giants Freddie Mae and Fannie Mac, tracks prices changes for individual homes. The agency's House Price Index is down 4.8 percent nationwide for the year ended in May. But the index only covers loans under the $417,000 limit for Freddie- and Fannie-backed loans.

The S&P/Case-Shiller index, which also tracks sales of individual homes, shows home prices off 15.3 percent for the year ended in April. But that measure only tracks homes in 20 large metro areas.

As with all aspects of real estate, price trends vary widely based on location; national statistics tend to mask wide disparities in price moves. Prices that soared the highest fell the furthest. Based on the S&P/Case-Shiller index, prices in Las Vegas are down nearly 30 percent from their peak, while homes in Charlotte, N.C., have lost less than 5 percent of their value.

Regardless of how you measure the drop in prices, the fundamental question facing home buyers, sellers, lenders and investors is: When have prices fallen far enough to offset the outsized price gains from the buying frenzy of the housing bubble?

Analysts say there are several historical benchmarks that are useful in estimating just how far house prices got ahead of themselves — and just how far they need to fall to returns to “normal.”

Mark Vitner, an economist at Wachovia, recently looked at two historical benchmarks to determine how far out of whack prices got during the height of the bubble.

One was the ratio of home prices to personal income. Home prices surged in large part because of the artificial boost in home buying power as easy-money lending practices put more money in buyers' hands than they could afford to pay back. Now, housing prices are falling back to levels that better reflect the average per capita income needed sustain a home purchase.

The price to own a home also bears some relation to the cost of renting instead. From 1983 to 1998, the cost of owning and renting equivalent housing was pretty much the same. But by the time home prices peaked in 2006, buying a home cost as much as 40 percent more as renting a similar home.

Based on those historical comparisons, and current trends income growth and rental prices, Vitner figures the housing market will hit bottom sometime between mid-2009 and mid-2010. When they finally do hit bottom, he estimates prices nationwide will have fallen on average between 22 and 29 percent.

Reuters contributed to this story.


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