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Why Home Prices Will Continue To Fall

4809381In the last week, a slew of economic reports and news articles have suggested that the U.S. housing market has bottomed out.

Don't believe it. More pricey areas, often in large metro areas, still have plenty of room to fall.

You wouldn't know it from Tuesday's release of the National Association of Realtors' index, which showed that nationally pending home sales had increased from the levels of one month ago.

Also on Tuesday, homebuilder D.R. Horton reported smaller losses, a day after Pulte Homes Inc. and Centex Corp. said that orders for new homes had been increasing.

And there was plenty of excitement last week after the S&P Case Shiller index seemed to show a mild rise in month-over-month prices for existing single family homes.

Well, not so fast. In reality, the seasonally-adjusted version of the Case Shiller index – which came out later in the day, after the initial headlines had been written -- reveals a continued month-to-month decline from April to May. And the year-over-year decline remains around 17 percent.

The reason to expect further declines in some areas is that the U.S. housing market has now bifurcated. It's true that some areas with lofty rises (and subsequent severe falls) may have stabilized.

Not so some of the more expensive areas, especially those in metro areas with houses that are over $750,000, which also experienced skyrocketing prices (a two- or three-fold increase since 2000 wasn't unusual) but are taking much longer to revert to normal.

Put another way, the U.S. housing collapse is affecting different markets differently. The yet-to-fall areas represent a small stock of the overall housing market, under 5 percent of the total, but a much greater share by total price.

This is the conclusion the Wall Street Journal also reached in an article on Monday. It looked at the differences between the less- and more-affluent suburbs of Chicago:

Inventory of expensive homes is rising. Overall, the inventory of unsold homes in June was enough to last 9.4 months at the current selling pace, down from 11 months a year ago, according to the NAR. But the supply of unsold homes priced above $750,000 swelled to around 17 months in June, up from a 14.5-month backlog one year ago. A recent forecast by analysts at J.P. Morgan Chase & Co. said it would take until at least 2012 for the expensive-home market to recover and that peak-to-trough declines could surpass 60 percent, compared to 40 percent for the rest of the market.

Defaults are rising, too. Among prime mortgages, jumbo mortgages are now leading delinquencies and defaults and are the fastest-rising category for defaults of all types of mortgages. The rate of 60-day delinquencies on prime-jumbo mortgages jumped to 7.4 percent in May, from 4.5 percent in November, according to First American CoreLogic. By comparison, 60-day delinquencies on prime-conforming loans reached 4.9 percent in May, from 3.6 percent in November.

A recent survey by the NAR found nearly three-quarters of real-estate agents said buyers were purchasing smaller houses due to tighter credit requirements. "We're in a 'trade-down' environment for the first time since the 1930s," says Kenneth Rosen, chairman of the Fisher Center for Real Estate and Urban Economics at the University of California, Berkeley.

High-end homes are also being hurt by changing perceptions about how much home one should own. For years, people were encouraged to buy the most expensive home they could afford because there would be a payoff when it was time to sell. But buyers can't count on that any longer.

The San Francisco Bay area is another example. Residential real estate throughout the metro area zoomed upward throughout the bubble, and has fallen dramatically in areas like Antioch, where prices per square foot have dropped from $240 in late 2007 to around $100 today. The ratios are similar for Vallejo and Richmond.

More expensive cities on the west side of the bay like San Francisco, Palo Alto, and Burlingame also experienced a doubling or tripling of home prices this decade -- even though their residents' salaries have not followed suit. Nor have residential rents. That's a signal that those localized housing bubbles have yet to deflate.

As I wrote in a column in February that ran the numbers for some buy-vs.-rent comparisons, the same phenomenon is true in New York City and Washington, D.C. too.

One explanation for this is that real estate is not as liquid as stocks or bonds. Psychology plays a larger role, and without foreclosures to establish market prices rapidly, denial can be a powerful force. Homeowners will invent reasons to differentiate their property from their neighbor's – even if the square footage, age, and lot sizes are identical – to avoid admitting that 2006's bubble price is now a memory.

(This is one reason why stock market crashes can happen in a period of months, but real estate crashes tend to take years. During a more modest bubble, Los Angeles home prices peaked in 1990 and didn't bottom out until 1996 or 1997.)

So what happens next? That depends on monetary policy, inflation expectations, interest rates, unemployment, consumer confidence, and the overall state of the economy. In some markets, whether the temporary Fannie Mae loan limit of $729,750 (up from $625,500) is extended past December 31, 2009 will make a difference. So will the expiry, or extension, of the $8,000 tax credit for some home buyers, currently scheduled to end on December 1, 2009.

Jed Smith, an economist in the National Association of Realtors' research department, also thinks the market is bifurcated. "Most of the market action is in the lower end of the market," he told me in an interview earlier this summer. Above $500,000 or so, "the market is substantially slower," he said. "For the jumbo end of the market, it's very much slower." (Jumbo loans exceed Fannie's limit of $729,750 and tend to be a few percentage points more expensive.)

"The outlook is probably for very modest price increases next year and market stabilization this year," Smith said. "I would guess that somewhere around the 4th quarter of this year we'll have agreement among most people that prices have stabilized."

Then again, asking a Realtor whether it's a good time to buy a house is a little like asking a used car salesman whether it's a good time to buy an automobile. Let's not forget that another economist for the National Association of Realtors, David Lereah, was the soothsayer who published a book titled "Why the Real Estate Boom Will Not Bust - And How You Can Profit from It" a few months before the housing bubble started to burst. He is, to put it delicately, no longer employed by the association.

A better way to come up with a prognosis might be to invoke another real estate agent maxim: location, location, location. Assuming the economy doesn't decay further, some areas may be stabilizing. But in many others, a historic boom means the historic bust is still to come.

Declan McCullagh is a correspondent for He can be reached at
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