How To Define the Bottom

The bottom is right under our noses but we just can’t touch it yet – every quarter it moves a little farther into the future – or at least that’s what it seems like. In the worst housing recession in modern times, we have seen home values plummet – nationally, homes have lost roughly a quarter of their value since the market peak in 2007. In some metropolitan areas, such as Las Vegas, Reno, Modesto, Naples, and Phoenix, home values have declined by more than 50 percent. But, more recently, the period of “free fall” in home values has ended in most metro regions and, while still declining, home values are dropping at a slower pace each month.

While it might be natural, given such news, to expect a bottom right around the corner, we believe that home values nationally will continue to fall until early 2013, even though some metropolitan regions will see a bottom this year. Zillow isn’t alone in this opinion as evidenced by the recent Zillow Home Price Expectation Survey in which a survey of 104 economists and analysts revealed a consensus expectation of another 0.7 percent decline in home prices nationally in 2012. They also downgraded their expectations of future price appreciation from the consensus just three months prior.

But that’s the picture just for home values themselves, which are only one part of the overall bottoming process in the real estate market. The full process is made up of a number of different milestones. The first step in the bottoming process is finding a bottom in home sales. Except for the downward blip in homes sales in mid-2010 associated with the expiration of the Federal homebuyer tax credits (a distortion where sales in those months were pulled forward by the tax credit), the “organic” bottom in home sales seemed to have occurred in early 2009.

The next step occurs when buyers with long time horizons (i.e., those who intend to own the home for a long period of time) start to enter the market, enticed by compelling values and less fear of residual home value loss because of their long perspective. Three types of buyers with long time horizons are investors, retirees and second home buyers. There’s ample evidence that these buyers have been active in the market in 2011 as shown by the fact that investors have been making up roughly 20% or more of sales in most months in 2011 and all cash buyers have accounted for roughly 30% of sales recently.

In this housing recovery, inventory levels are also a key number that analysts need to track. Currently, inventory levels have fallen substantially. For-sale home inventory declined 23 percent on a year over year basis and dropped by 6 percent from December 2011 to January 2012. Inventory in some areas is even relatively tight.

With the improving overall economy and a slowing pace of home value decline, mainstream buyers will next enter the market in larger numbers. This influx of housing demand will serve to further put a bottom under prices, which will in turn inspire further home buying confidence. We believe we are just starting to see this dynamic play out in the market. February existing home sales were up almost 9% from year-ago levels, February pending home sales were up a similar amount on a year-over-year basis, February new home sales were up 11% from the prior year, and both housing starts and permits were up 34% from year-ago levels. Expect to see continued strong sales growth in the 2012 home shopping season.

Concurrent with increased home sales, we’ll see sub-markets within metro regions begin to show strongly differentiated trends in home values. There has always been some geographic variation in home value trends, but this pattern will become much more pronounced this year with some ZIP codes doing quite well while others in the same metro perform less well. This means that overall home values at the metro level may still be falling even while sub-areas within the metro are heating up and seeing home value appreciation.

The final stage of the bottoming process will be when home values measured at the metro level actually stop falling. As noted, this will happen in some metros this year while still others may not see this milestone until 2013. Once we have hit the bottom, we will most likely remain there for two to four years until we start seeing normal home value appreciation rates of 2 to 4 percent again.