Glimmers of Light on Home Prices

In the second half of 2009, the housing market seemed to catch its breath after struggling to recover from the most severe downturn since the Great Depression. The first-time home buyer’s tax credit and low mortgage rates lured buyers who’d been dithering and helped move the glut of foreclosures that have been dragging down home values. Sales began ticking up, and home prices stabilized after a three-year downward spiral.

But the correction isn’t over yet. Credit is still tight, unemployment is high, and more foreclosures are coming. Even with the extension and expansion of the tax credit to include move-up buyers and an upward trend in sales, home prices will continue to edge lower through next spring. The U.S. housing market won’t begin to look healthy again until at least 2011.

The price picture

From the beginning of the downturn in mid 2006 to June 30, 2009, the median price of an existing home nationwide fell by 30%, or 11% annualized, according to Fiserv Lending Solutions. The median home now sells for $174,000-about what it sold for in 2003. Among the cities that Fiserv tracks, Detroit-victim of subprime lending and sky-high unemployment-suffered the most, with an annualized decline of 22% in its median home price over three years and a 33% plunge in the year that ended June 30. Detroit was followed closely by Las Vegas, Phoenix, Merced (Cal.), Miami, and Modesto (Cal.)-all at the epicenter of the boom-bust quake.

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Over the past year, prices dropped 15% across the U.S. and rose in only two cities: Clarksville, Tenn. (up 1%), and Johnson City, Tenn. (2%), reflecting demand for homes by an influx of retirees to the Blue Ridge Mountains.

But between the first and second quarters of 2009, the nationwide median home price rose slightly, by 1.4%, according to Fiserv. That’s the first such increase since 2006 and, says Fiserv chief economist David Stiff, “the first good news we’ve had.” But Stiff is quick to warn that one grace note doesn’t make a tune.

Given that prices tend to stabilize about a year after sales begin to recover, Fiserv expects prices to bottom out in mid 2010. It forecasts that the median home price will have fallen by 7.5% in 2009 and will drop another 9.2% in 2010, to a level not seen since 2001.

Sales have been picking up steam since April, and in July, they increased year over year for the first time since November 2005. The increase was driven by first-time buyers seeking to capture the $8,000 tax credit and by bargain hunters and investors lured by discounts of 15% to 20% from market value on foreclosed homes and short sales (properties sold for less than what was owed on the mortgage). Federal intervention in the credit markets helped shore up mortgage lending at superlow rates.

In its most recent report, the National Association of Realtors said that sales of existing homes (including single-family houses, townhouses, condos and co-ops) rose 9.4% in September compared with the year before, with the strongest rebound in the Northeast (12%) and the weakest in the West (6%). Inventory fell by 15% from the year before, to just under eight months’ supply (the time it would take to sell the current inventory at the current pace of sales). That’s the lowest level in two and a half years, but above the four- to six-month supply that indicates a market balanced between buyers and sellers. The condo market still staggered under an 11-month supply.

Strong buyers benefit

Affordability is the outlook’s silver lining. Fiserv’s data show that nationally, the ratio between median family income and the median home price has fallen to 2.8—just under the long-term historical average of 2.9. Renewed affordability combined with historically low mortgage rates present an opportunity for home buyers who have sterling credit, secure jobs and a plan to live in their home for many years.

Eager to get a good deal, David and Kiara Powell of Minneapolis shopped for a home last summer. The couple, both 31, had been living in Kiara’s condo, which she purchased near the top of the market in 2005. Because the condo market in Minneapolis is still glutted, says Cotty Lowry, the Powells’ agent, condo sellers who bought in 2005 or just before should expect to list their units for 80% of the original purchase price. Instead of taking the hit, the Powells chose to keep their condo as an investment property and rent it out.

The Powells found their home on the first day they began looking-a house with three bedrooms and two bathrooms on one-fifth of an acre. Built in 1926, the 1,898-square-foot home was smaller than they wanted, but it was completely renovated and overlooked a park on the shore of Lake Harriet. Plus, it was a 10-minute commute to their jobs downtown. They made an offer the next day.

The seller had originally listed the home for $985,000 but had dropped the price four times over four months. The Powells signed a contract for $695,000. They made a substantial down payment and financed the purchase with a conforming first mortgage ($417,000), at a rate of 5.25%, and a line of credit for the balance. They closed and moved in August.

The Powells benefited from the stagnating trade-up market, which in Minneapolis and many other metro areas has too much inventory, too few buyers and too many sellers who refuse to face reality. “They still believe their homes are special,” says Lowry. He points out, for example, that his South Minneapolis Lakes market has a glut of homes for sale priced between $600,000 and $1 million. In August, the National Association of Realtors reported that more than two-thirds of all sales were for entry-level homes, priced under $250,000.

Fiserv’s Stiff thinks the trade-up market will remain weak for a long time because of stalled household incomes, high unemployment and the desire by many consumers to cut debt. He expects that the expansion of the home buyer’s tax credit (to include higher-income and trade-up buyers) will shore up demand until the job market begins to recover, mostly by inspiring those intending to buy anyway to buy sooner. It would be nice if the tax credit also helped boost average prices (the greater the number of higher-priced homes that sell, the higher the median home price), but another wave of expected foreclosures may overwhelm any benefit.

The face of recovery

Although the credit markets and financial system remain troubled, the real fly in the ointment is foreclosures, says Mark Zandi, of Moody’s Economy.com. The greater the number of distressed sales, the greater the continued pressure on home prices. In September, just over four million of the 54 million first mortgages in the U.S. were in serious trouble. With a national unemployment rate already above 10%, more struggling homeowners will enter the red zone with the next surge of interest-rate resets on adjustable-rate loans.

Relatively few borrowers will qualify for the government’s program of loan modification, and Zandi expects that about a third of those who do will default (many for a second time) within three years. Meanwhile, about a third of first-mortgage borrowers are underwater-owing more on their loan than their home is worth. That doesn’t necessarily mean they’ll end up in foreclosure, but it makes them vulnerable and potentially perpetuates the spiral of price declines. Zandi thinks the number of foreclosures won’t ebb until 2011.

Fiserv doesn’t foresee a year-over-year gain in the median home price nationwide until mid 2011, and then it expects a bump of just 3.6%. In markets such as metro Seattle and the state of Texas, which mostly avoided the speculative bubble and have relatively strong job growth, Stiff expects one or two years of above-average price appreciation, followed by a return to the historical average-an annual increase equal to a little less than the rate of inflation, plus one percentage point.

In markets that experienced the biggest price declines over the past three years-located in Arizona, California, Florida, Michigan, Minnesota and Nevada-prices may rebound sharply, Stiff says, possibly even by double digits, as the bravest and most optimistic buyers and investors jump back in. However, constraints on mortgage lending because of stricter standards will limit the bounce, after which prices will relapse and flatten.

All real estate REALLY is local

Nationwide, sales of existing homes have risen 9% in the past year. But the numbers vary-sometimes a lot-by region. The Northeast led the nation with a 12% boost in sales, followed by the South (11%), the Midwest (8%) and the West (6%), according to the National Association of Realtors.

We looked at recent home sales in three metro areas. In Santa Barbara County, sales in the past year fell by 3%. In Omaha, sales increased by 15%. In Edison, N.J., about 45 minutes from New York City, sales fell by 10%. But in each of those areas, the fastest-selling homes had the best mix of location, condition, terms and priceÑand price ultimately trumped all. Smart sellers set prices below the competition from the get-go and avoid multiple price cuts.

Loan Rates Will Edge Up

Interest rates can only go up from here. The 30-year fixed rate for a conforming loan ($417,000 or less) hovered around 5% for most of 2009—the lowest rate in 38 years. Jumbo rates fell to a four-year low (in early November, 5.3% for a conforming jumbo of up to $729,750 and 6% for a traditional jumbo). By mid 2010, conforming rates will rise to 5.5% or above and close the year at 5.75% to 6%, says mortgage analyst Keith Gumbinger, of HSH.com, a financial publishing company. Jumbo rates will be 6.25% or a bit higher by the end of 2010. Gumbinger’s forecast assumes that the economy will improve a bit and inflation will reappear.

The wild card in that forecast: whether the Federal Reserve stops buying Fannie Mae, Freddie Mac and Ginnie Mae mortgage-backed securities in March, as planned. Gumbinger says the program has probably tamped down rates by about three-fourths of a percentage point. The Fed could carry on if it thinks the mortgage market hasn’t recovered enough, which would keep rates closer to current levels.