At last, sanity is returning to the housing market. Appreciation is still strong -- in fact, median U.S. home prices in 2005 will surpass 2004\'s gain. But forecasters expect the pace to moderate in 2006, closer to the historical average of 4% to 6%. For homeowners, that\'s still an inflation-beating return. Home buyers can expect a retreat from the bidding wars and no-contingency offers that have kept many on the sidelines. And sellers will have to expend more effort to snag a fair price.

\" /> What's Your House Worth?

Buying & Selling a Home

What's Your House Worth?

This time it's for real: The hot housing market is gradually cooling down. To see how moderating price hikes affect your town, check our survey of 100 cities.

At last, sanity is returning to the housing market. Appreciation is still strong -- in fact, median U.S. home prices in 2005 will surpass 2004's gain. But forecasters expect the pace to moderate in 2006, closer to the historical average of 4% to 6%. For homeowners, that's still an inflation-beating return. Home buyers can expect a retreat from the bidding wars and no-contingency offers that have kept many on the sidelines. And sellers will have to expend more effort to snag a fair price.

Economists have been predicting the return of moderate appreciation for several years in a row. But this time, there's growing evidence they might be right. First, the inventory of existing homes for sale edged up in 2005. It's not yet at an equilibrium between sellers and buyers, but it's getting closer. Second, the National Association of Realtors expects total sales of both existing and newly built homes to decline in 2006. Third, the inventory of condos and co-ops for sale made a huge leap in the past year -- by almost 25%.

Mind you, few experts are predicting a market crash. Economists, including Ben Bernanke, the likely new chairman of the Federal Reserve, cite strong fundamentals that support the housing market, including steady growth in jobs and income, plus historically low mortgage rates (even though rates have begun to climb). Continuing growth in the number of households means more buyers. And limits on home building in some areas will also keep demand strong.

But sooner or later any run-up in prices runs out of steam. In one scenario, price appreciation in overheated markets (mostly on the coasts) will slow and prices may even decline, while less-frenzied markets will continue to pick up speed. Gary Taylor, 44, and Melody Wofford, 50, are already caught between those two worlds. They are trying to sell their current home in Geneva, Ill., 40 miles west of Chicago, and return home to family and friends in Nashville. In 2003 the couple purchased their 1917 Craftsman Foursquare house for $365,000. Last September they put it on the market for $474,000. In November, they reduced the price to $465,000 but still had no offers. "People say, 'great house,' but they're not ready to buy. I think they're waiting until the new year to see what will happen to the market," says Taylor.


The couple can't afford another drop in the price of their Chicago home because prices in Nashville have been chugging higher in their absence. They believe their former Tennessee home would cost as much as $100,000 more today than it did when they sold it in 2003. Plus, they're hoping to make a hefty down payment so they can afford payments on a 15-year fixed-rate mortgage.

It's different this time

Given their inaccurate predictions of price slowdowns in the past, why should we believe housing economists this time? That's exactly what they asked themselves at the fall forecast meeting of the National Association of Home Builders. Mark Zandi, chief economist and co-founder of, an independent research firm, confessed that he had been "dead wrong" for the past two years. He cited three reasons: He believed that mortgage rates would rise, and they didn't. He underestimated the creativity of mortgage lenders, who came up with affordable new variations on adjustable-rate themes. And he failed to anticipate the persistence of real estate investors.

Now, says Zandi, those forces are becoming "less potent." Interest rates on 30-year fixed-rate loans have begun to rise, and they could reach 7% or more by the end of 2006 -- a level at which most economists agree that buyers could begin to put the brakes on home purchases. Zandi says lenders are beginning to self-regulate and to become less aggressive in courting buyers, and they may find it difficult to come up with the next new thing. And he thinks investors in many "juiced-up" markets sense that the markets are topping out, especially when it comes to high-end condos.

In the past, you could assume that as long as there were plenty of jobs, home prices wouldn't decline. Not anymore, says David Stiff, chief economist at Fiserv CSW, which supplied the figures in the database we have compiled. Those two factors came unlinked during the recession of 2001, when home prices continued to climb as unemployment rose. Now buyers may not be able to afford the big run-up in home prices despite a growing number of jobs.


Zandi says markets in which home prices have appreciated significantly above their historical averages are seriously overvalued. In that group he now includes all of California and Florida, much of the Northeast corridor (from Boston to Washington, D.C., excluding Philadelphia) and parts of the markets in Minneapolis-St. Paul and Chicago. Those areas account for almost half the value of the nation's housing stock -- up from about one-third in late 2004. If all those markets cool off at the same time, loss of construction jobs, waning confidence among homeowners and consumer belt-tightening could have widespread repercussions, provoking a nationwide slump in housing prices. When might we see prices fall? Zandi ventures a vague guess -- within two to three years.

But the longer the party goes on, the worse the hangover will be.

Precarious perches

Among the metro areas Zandi identifies as most at risk for declining prices is Bakersfield, in California's Central Valley, where coastal Californians have flocked to find relatively affordable housing -- a median price of $235,000, versus $544,000 for the state of California as a whole. Although the city took first place in the U.S. for annualized price appreciation over the past three and five years, it fell to third, tied with Naples, Fla., in one-year results. Local real estate agent Charles Doremus confirms the loss of momentum, though he says it's like "going from 200 miles per hour to 180."

Another of Zandi's at-risk cities is Pensacola, on the Florida panhandle. The region hasn't garnered nearly as much bubble press attention as south Florida, but the loss of homes to Hurricane Ivan in September 2004 has fueled double-digit appreciation, and in some communities, prices have gone wild.


In Fort Walton Beach, about 40 miles to the east, growth in population and jobs are the drivers. In CSW's one-year results, Fort Walton Beach-Destin took first place, with price gains of 49%. Fort Walton Beach's mayor, Mike Anderson, says the town and its white-sand beaches have finally been discovered. But local real estate agent Cindy Purves says a slowdown began about midyear and describes the market as returning to sanity from insanity.

In both Bakersfield and Fort Walton Beach, housing prices were driven even higher by investors and speculators. That has made it tough for first-time buyers and some move-up buyers to afford a home in their own town. But for homeowners who got in early, the ride has been sweet.

One native of Fort Walton Beach for whom the market has worked well is Debbie Collins Culbreth, 49, principal of Ocean City Elementary School. Last summer Culbreth bought a three-bedroom waterfront home with 2,800 square feet and stunning views. She put down nearly $300,000 on the $820,000 home -- the proceeds from the sale of her former home, a waterfront condo, which she bought in 2001 for $157,000 and sold in June for $425,000. If prices fall, it's no matter. Culbreth got married over the summer, and she and her husband expect to live there indefinitely.

Rising star

The beat of Nashville's housing market has been strong and steady, resulting in a price gain of 8.1% for the year. Music City could just as easily be nicknamed "corporate relo city," given the influx in recent years of major businesses, such as Dell; Asurion, a service provider to the wireless communications industry; and Caremark, a pharmaceutical services company. Gary Taylor's and Melody Wofford's real estate agents, Mike and Candie Worsham, note that young Nashvillians once moved to Atlanta for jobs, but now they stay home or are returning.


The Worshams describe Nashville as "a small town with a big-city feel," but it's the small-town -- even rural -- aspect that will rivet visitors from congested regions. In November, Gary and Melody flew to Nashville from Chicago so the Worshams could show them homes in nearby Williamson County. Within a 20-minute drive of downtown, a ring of forested hills bright with fall colors comes into view. Just beyond are expanses of pastureland dotted with estate homes that have enough land to justify the name. To top it off, the southern hospitality is real, not rote. The county seat is Franklin, Tenn., which is 20 miles south of Nashville. It features a Confederate war memorial in its town square and used to be small, slow and isolated. Not anymore. Nissan plans to move its U.S. headquarters there over the next couple of years.

Gary and Melody look at five single-family homes with at least a half-acre of land priced under $350,000. To buyers coming from, say, California, where the median home price in several cities tops $600,000, finding five such properties listed for sale might seem astonishing. The couple tour a two-story, three-bedroom home on an acre of land, which lists for $309,000, and Gary paces off the yard to see if there's room to add a master suite. But their favorite is a Southern-style ranch, with a master suite downstairs and two bedrooms and a bath upstairs, selling for $344,900. They can't afford to make an offer yet, and they hope the house, or one with similar appeal, will be available when their Geneva home finally sells.

Meanwhile, the couple's agent in Geneva recommends that they reduce the price further. That would make their home compete better with the less charming but brand-new homes being built on the edge of town. Candie Worsham, in Nashville, urges patience. For now, the couple will hang tight, but it looks as if winter might feel longer than usual in Chicago.