At last, most indicators point to a genuine recovery in the housing market. By Pat Mertz Esswein, Associate Editor January 1, 2013 After nearly six years of deflating home prices, the housing market is finally, firmly on the path to recovery. For the year ended September 30, home prices nationwide rose by 4.9%, and the median price for existing homes jumped by almost $14,000, to $185,000, according to Clear Capital, a provider of real estate data and analysis. Buyers turned out in greater numbers in 2012, driven by affordable homes and historically low mortgage rates. Strict guidelines for getting a mortgage, however, continue to hinder the ability of some would-be buyers to close the deal.SEE OUR SPECIAL REPORT: Buying and Selling a Home in 2013 All the positive trends for the housing market will drift into 2013, becoming more entrenched as the economy picks up steam in the second half of the year, says Celia Chen, a housing economist at Moody's Economy.com. Market observers agree that home prices will keep rising in 2013, but they disagree by how much. Clear Capital's forecast is at the higher end, with an overall gain of about 5% in 2013. Kiplinger expects a more modest 1% or 2% hike. As the recovery blooms, "sellers will smile more, and buyers will need a more concentrated focus," says Lawrence Yun, chief economist for the National Association of Realtors (NAR). Home buyers can expect to face stiff competition for fewer highly desirable homes. Advertisement Correcting the Correction Home prices rose or remained flat in about two-thirds of the 313 cities Clear Capital tracks and continued to fall in the remainder, mostly by single-digit percentages. Fifty cities experienced double-digit increases in home prices, led by Phoenix, with a gain of 28.4%. Such spikes reflect a "correction to the correction," says Alex Villacorta, director of research and analytics for Clear Capital. The properties had become undervalued when measured by affordability. The benchmark of affordability (the ratio of median home price to median family income) stands at 3.0—right at the historical average and up a tad from 2011. Another measure, the percentage of monthly family income consumed by a mortgage payment (principal and interest, using a mortgage rate of 4%) is 14%, up slightly from 2011, when it was 12%. Many of the cities that are doing the best are those that Villacorta describes as "first in, first out," including Phoenix and many cities in Florida and California's Central Valley. The real estate bubble began to burst in those cities earlier than in many others, and the cities have begun to recover earlier, too. Advertisement Other cities—including San Francisco, San Jose and Washington, D.C.—are relatively expensive again, driven by strong job growth, especially in technology and defense. Utah's largest cities (Ogden, Provo and Salt Lake City), as well as Denver and Little Rock, Ark., never experienced a huge drop-off in home prices, and as a result they posted gains in 2012 that exceeded their losses since the peak. Several cities have seen steady gains: Austin, Tex., Pittsburgh, and the upstate New York cities of Buffalo, Rochester and Syracuse. They neither boomed nor busted; they just kept plugging along. The large U.S. cities where home prices remained flat or fell in 2012 suffer from either a surplus of distressed properties or uninspired economies—or both. They include Chicago, Louisville, Ky., Memphis, New Orleans, the greater New York metropolitan area and Philadelphia. Buyers Get in the Game For several years, investors armed with cash have been scooping up distressed and undervalued properties, especially at the market's entry level. In 2012, that drove double-digit price spikes in Phoenix, Cape Coral, Fla., and other cities. Advertisement As home prices rise and the economy improves, investor influence will wane. Villacorta explains the process: Investors buy undervalued homes, which are often vacant and in poor shape. They remodel them, and by renting or selling them, attract occupants. The neighborhood revitalizes, and prices begin to rise. A year or so of consistently rising prices instills buyers and sellers with confidence that the bottom has been reached and it’s time to jump in. As that sentiment catches fire and spreads, the market transitions to include more traditional buyers, who pick up where investors left off. Meanwhile, as the economy recovers and hiring increases, housing demand strengthens. High rental occupancy and rising rents are encouraging renters to move on to homeownership. Also, as home prices rise, owners who were underwater or nearly underwater—without enough equity in their homes to pay off the mortgage—will emerge from the sidelines and start selling and buying homes, says Molly Boesel, a senior economist at CoreLogic, a mortgage data firm. The company reports that 1.3 million homeowners were lifted out of negative equity between year-end 2011 and June 30, 2012. Rising Sales, Tight Supply In the past year, sales of existing homes and condos rose by 11%, to 4.75 million. The NAR expects sales to rise to nearly 5.1 million in 2013. Sales have increased across all regions and all price categories. "That's a reflection of a very broad-based recovery," says Yun. Advertisement In 2011, most activity occurred at the low end of the market, so the number of inexpensive homes for sale dropped off in 2012. "It was like someone switched on the light and half of the inventory disappeared," says Yun. That led to a reduction of sales activity in the very low price range, especially in the West. That also explains why the median home price has risen dramatically in the past year. More transactions have occurred in the middle and upper home-price tiers. As demand grows, where will the supply of homes come from? That could turn out to be a problem for buyers—one that leads to higher prices and more bidding wars. Many would-be sellers of existing homes have waited for prices to stabilize or improve—but most of them are also planning to move up or downsize after they sell their home. So it's a wash in terms of net inventory. And although new-home building has increased, it’s still half the normal historical average. That's not enough to satisfy demand, says Yun. But builders are constrained now by difficulty finding financing, and many skilled laborers left the industry after the housing bust. Distressed properties are still adding to the supply of homes, but in 2012 foreclosure filings dropped to a five-year low nationally, according to RealtyTrac, which monitors the foreclosure market. RealtyTrac vice-president Daren Blomquist expects the number of foreclosures nationwide to continue to decline in 2013, partly because lenders have finally realized that they lose less money on short sales (homes sold with lenders' approval for less than the owners owe on their mortgages) than on foreclosures. However, lenders in some states (notably Florida, Illinois, New Jersey and New York) have a backlog of foreclosures resulting from the robo-signing debacle in 2011 and new state legislation. As they catch up, the foreclosure rate will spike in those states, but only temporarily. Despite most housing signals flashing green, confidence in the market is still blinking yellow. Chen says it is tied to concerns about the economy—especially lending, hiring and consumer spending. Continued recovery of the housing market also depends on how adeptly Congress deals with the spending cuts and tax hikes looming at the fiscal cliff and whether the mortgage-interest deduction survives the process. Those may seem like big ifs, but most economists say the majority of them will be resolved by the second half of 2013, giving the housing market the shot in the arm it needs to stay on the path to full recovery.