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Home prices: Where's the bottom?

Down 3.3 percent in the past year, median US home values are still 7.6 percent above 2004 levels.

By Staff writer of The Christian Science Monitor / January 2, 2008

A house for sale is seen in Albany, NY.

Mike Groll/AP

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One of the big questions that hangs over both the US economy and individual Americans in 2008 is a seemingly simple one: What's a house really worth?

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The problem is, the housing market is in an unusually volatile state. Home prices are posting rare declines in many cities, and potential buyers and sellers alike are wondering where the market will bottom out.

In this decade's raging real estate market, property values became untethered from reality, economists say. Home prices rose much faster than people's incomes or the rent that houses could earn when leased.

Now, home prices are in the process of moving back toward a more normal relationship with those fundamentals, housing experts say. But that doesn't mean that home prices will travel a predictable route.

"We think [the median price] is going to drop probably about 10 percent," says Patrick Newport, a housing economist at Global Insight in Lexington, Mass.

But "there are many possible paths" to a new equilibrium, he adds.

Some paths might involve more of a rise in rents or personal incomes – and a smaller decrease in home prices – over the next several years, for example. In effect, that would allow home prices to stay fairly flat while other factors adjust.

On Dec. 31, for example, the National Association of Realtors gave its latest numbers on monthly sales volumes and prices for previously owned homes. It showed that over the past three months, both sales volume and prices have been fairly stable.

"Near term, existing-home sales should continue to hover in a narrow range, just as they have since September, and that's good news because it'll be a further sign that the housing market is stabilizing," Lawrence Yun, the trade group's chief economist, said in releasing the data.

America's median home price is now $210,200, down 3.3 percent from a year ago but 7.6 percent above its 2004 level.

Where prices head next could affect an economy that has hit a slow patch and that confronts a high risk of recession. Perhaps most significant, falling home prices could further exacerbate a foreclosure rate that is already much higher than in past housing downturns. The further home prices fall, the greater will be the number of recent buyers whose homes are worth less than what they owe on mortgages. This creates a volatile situation in which these "under water" buyers may opt to walk away from their homes and find a cheaper rental.

A rising foreclosure rate could push prices down faster, because a foreclosed home tends to sell at a much lower price than the same home sold under a typical broker listing.

Rents vs. home prices

Regardless of foreclosures, however, many economists expect further home-price declines. That's because prices surged so far ahead of incomes and rents during a long boom earlier this decade.

"Historically there's a relationship between value of a house and equivalent rents," says Bob Walters, chief economist at Quicken Loans in Livonia, Mich.