RealEstateEconomyWatch.com

During the past several years, the nation’s housing sector has been weighed down with a disturbing trend that had been absent since the Great Depression: falling home values. Most of us stood in awe, as we observed the devastating impact falling home prices had on the housing industry. The bad news is that home values are expected to decline further during the first half of this year; the good news is that prices do not have much further to fall.

Falling home prices during the past several years nearly crippled the housing sector. Just the expectation of falling home prices unnerved potential homebuyers. Many trade-up buyers postponed purchasing because they did not want to purchase a home that was losing value. Other trade-up buyers were unable to purchase a larger home because the equity in their current home had lost too much value to adequately fund the down payment required to acquire a larger home.

Resort buyers postponed purchasing vacation properties for similar reasons: they would not purchase a resort property that was losing value; and they no longer could afford to purchase a resort property due to the substantial loss incurred on the equity in their primary residence. Many investors shied away from investing in property because falling prices introduced greater risk to their return on investment. At some point, however, falling prices create opportunities for investors because lower priced properties generally have better cash flows than higher priced properties, everything else the same.

On the other hand, falling home values had a favorable influence over first-time buyers. Immediately after the real estate boom, many first-time households preferred renting over owning due to the relatively high home prices, courtesy of the boom. But as home prices continued to fall, more and more first-time households began to choose homeownership over renting as homes became more affordable.

On balance, plummeting home values during the past several years wreaked havoc in the housing markets. According to the Case-Shiller 20-city Home Price index, home values plunged 29 percent to a 146.6 index in October 2009 (our most recent data), from a peak index of 206.5 posted July 2006. It is no coincidence that housing demand literally dried up during this period, as evidenced by an over 30 percent drop in both existing and new home sales.

However, most of the damage has already been done. In the past six months home prices have shown signs of stabilizing.   The Case-Shiller 20-city index has risen 5.3 percent since April of this year. The worst may be over but it is likely that prices may drop further due to a mounting foreclosure problem. According to a recent Realty Trac report, there were almost 3 million foreclosure filings last year, an all-time record. Foreclosures are one of the primary reasons for falling home prices since a foreclosed homes sell at a discount to non-foreclosed homes, bringing down the mean and median price for all homes sold in a marketplace.

Unfortunately, there has been an unusually large build up of mortgage loans that have been seriously delinquent over the past several quarters. According to the Mortgage Bankers Association’s mortgage delinquency survey, the 90 days or greater past due category is at an all-time record and many of those loans are likely to result in a foreclosure filing. The pipeline of foreclosure filings is filling up quickly which does not portend favorably for future home values.

Although home values may resume declining due to a precarious foreclosure situation, the bulk of the price correction has already occurred. The inventory of homes available for sale has been reduced markedly during the past two quarters, including the number of vacant homes. Further, in many locations (e.g., metros) today’s lower home prices are better aligned with local market rents, providing some support for homeownership vis a vis renting. To this end, further drops in home values should be limited during the first half of this year.