US Housing: It'll get worse

With home prices plunging by more than 30% in some markets, bargain-hunters are ready to pounce.

But it may pay for buyers to wait. Many housing experts say that the worst-hit metro areas have even farther to fall, and could see total drops of as much as 50%.

The housing boom was unprecedented in U.S. history, and the correction will be as well.

Many erstwhile bubble cities have sustained particularly brutal hits. The median-price of a home in Sacramento, Calif. was down 35% during the three months ended May 31 compared to the same period last year, according to the real estate web site Trulia.com. In Riverside, Calif. prices fell 29%, while San Diego prices dropped 26%.

Smaller cities in California's Central Valley, such as Stockton (-39%), Modesto (-37%) and Bakersfield (-29%), also recorded steep declines.

Outside California, hard-hit markets include Phoenix (-18.8%), Las Vegas (-22%), West Palm Beach, Fla. (-32%) and Cape Coral, Fla. (-35%).

Youngblood expects that these markets will likely endure total price drops of 50% or more.
The smart money

Indeed, prices are falling faster and further than in any other post-war housing bust. During the bust in Austin, Tex., which started in 1986 and is one of the worst on record, prices fell 25%, according to Local Market Monitor, a financial data provider. And that cycle took four years to bottom out.

In other major downturns, prices in Los Angeles fell by 21% during a six-year period in the 1990s, and Honolulu home prices saw a decline of 16% in the five years starting in 1994.

Youngblood's forecast is quite plausible, it especially significant that the smart money, investors in the S&P Case/Shiller Home Price Index, are still buying futures as if they expect prices to continue to plummet.

The index, which tracks the sale price of specific homes as they are sold and resold over the years, is considered to be one of the most accurate home price indicators.

The people who are putting their money where their mouths are betting on more losses.

Specifically, Case/Shiller investors are betting that Las Vegas prices will fall an additional 22% by November 2009. Los Angeles futures predict a loss of 24.2% through November 2009, while investors expect to see Miami down 21.6% by then.

These markets may have a hard time recovering because, according to Perna, people are afraid to buy right now, because they're concerned about over-paying. That helps explain why price depreciation seems to be accelerating.

The most severe declines are happening right now.

This correction was inevitable, in Youngblood's opinion; home price gains had simply out-paced income by far too much to be sustained.

Historically, home prices have averaged about four times wages. Whenever homes got significantly more expensive, people could not afford to buy and home prices fell back.

But local price-to-income ratios are still out of whack even after steep price declines, which means prices have further to fall. In Los Angeles, where the ratio peaked at 22.7, according to Youngblood, it's still in the high teens. Home prices would have to come down another 40% or so to get that ratio back into the single digits.

And it's not just the housing fundamentals that lead Youngblood to expect more drops; he also cites the local economic conditions.

Bubble cities are now seeing fleeing employment conditions. In Miami, the unemployment rate rose 34.3% between April 2007 and April 2008, according to Youngblood. And the job picture in California cities, where many jobs were housing related, has been even more disastrous.

Housing was a key economic engine for towns like Riverside, Stockton and Modesto during the boom, according to Zandi. Builders, real estate salespeople, mortgage brokers and lenders, and even retailers, like Home Depot and Lowe's , depended on growth in the sector.

In all those deteriorating housing markets, it's a double hit.

Ten of the 11 cities with the highest unemployment rates in the nation are now in central California, with El Centro, at 18.4% in April, leading the way. Other double-digit disaster areas were in Merced (12.3%), Yuba City (11.8%), Modesto (10.7%), Visalia (10.3%), Hanford (10.2%) and Fresno (10%).

Many of these cities are also among the leaders in foreclosure rates. As more foreclosed properties hit the market, prices are further depressed.

The price drops reflect a wave of distressed sales of bank-owned properties and discouraged sellers.

Not all analysts are pessimistic. Richard DeKaser, chief economist for National City Corp points out that, thanks to the price declines, the national market is the most affordable it's been in years.

With the national median price of a single family home at $204,229, mortgage rates around 6% and the average household earning nearly $50,000, the average home buyer spent about 23.2% of their income on housing during the first quarter of 2008. That's down from 2006, when homeowners spent an average of 29% of their income on housing.

While he expects home prices to stagnate for the next five years, Youngblood's 50% price decline forecast is a little extreme.

But that target is realistic, after taking inflation into account. In markets where prices have fallen 35% or more, and remain depressed through five years of 4% inflation, home prices in real dollars will absorb an additional 20%-plus hit. That would push price declines to over 50%.

Of course, there are plenty of wild cards that could affect home price trends, such as the election, Congressional legislation, unemployment, gas prices, and interest rates.