How Low can Home Prices go?


    With the expiration of the home tax credit we can now expect home prices to roll over and continue their downward trend. The question is: How much lower can they go before the market finally clears? As you can see from the chart above. nationwide home prices are currently hovering around $166,000, but this is very misleading because of the large fluctuations in regional home prices (West expensive, South and Midwest cheap). But it does show that in aggregate, home prices could fall to around $150,000 to get back within the historical norm. This would represent at least another 10% decline. This is likely a conservative estimate because post bubble prices usually overreact to the downside which could send nationwide prices into the $125,000-135,000 region.  However, there is one key variable in the housing market, and that is interest rates. If rates increase even 100 bps, this could have a very negative effect on prices. Currently, rates are at historical lows of around 4.7% which is allowing people to afford more house than they would normally be able to purchase. If you look at a longer term chart of mortgage rates, you will see that they usually average between 6-8%. Since  it is hard to see rates moving any lower (unless the Federal Reserve steps in), one would have to conclude that rates will eventually find their way back to the historical range.  This should keep prices capped for an extended period of time as the market establishes an equilibrium.

   One last thing to remember about the housing market is that there is no need to try to time the bottom. The housing market, unlike stocks or other asset classes, moves incredibly slowly. If you look at other boom/bust cycles in the housing market, you will see that once prices hit bottom, they usually stay there for a while and tread water (3-5 years). So don't believe the liars at the National Association of Realtors who claim that you have to "get in now" to get the best price. When it comes the housing market, patience is a virtue.    



  1. One component you haven't discussed is the impact of deflation in futher deblitating home price fall. The huge deflationary cycle means that credit implosiong (IOUs not getting paid) is starting again (double dip?). Consumers will not want to spend on a falling asset or not be able to get credit which is disappearing.

    Also, what is the primary asset of just about every bank? Mortgages! And everyday, these assets are declining in value (IOU defaults).

    So, my prediction, housing will fall in some areas by as much as 90% by end of this massive deflationary correction. Many houses will be sold simply for the taxes owed.

  2. Thanks for the comment. Deflation would be the likely outcome if it was not for the Federal reseve who will simply print as much money as possible to prevent deflation. I dont agree with their policy but this is the reality. I find it hard to believe that prices will fall 90% (perhaps 20-30%) but that would only be in the bubble areas like California and Florida. In other areas like the midwest and south prices are not very high and should not fall much further. The most likely outcome in my opinion is that the Federal Reseve prints more money, debases the dollar and prevents nominal asset prices from falling much further. In inflation adjusted prices homes will defintely fall. I don't think prices will bottom until 2011-2012 but this of course depends on government policy. I was strongly against the tax credit which artificallly boosted prices and prevented the market from clearing. I belive that the free market should set prices instead of the govermemnt.

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