It used to be that when real estate markets went south, they did so in a somewhat leisurely fashion. Buyers stopped buying and builders stopped building, but prices would stagnate or get a little soft — not plummet overnight like the stock of some corporation that’s been flown into the side of a mountain.

It used to be that when real estate markets went south, they did so in a somewhat leisurely fashion. Buyers stopped buying and builders stopped building, but prices would stagnate or get a little soft — not plummet overnight like the stock of some corporation that’s been flown into the side of a mountain.

Housing prices were "sticky" on the way down because homeowners would look at what their neighbor got for their house at the height of a boom, and decide to hold out for the same — or at least something in the ballpark, even if that meant waiting a long, long time.

That’s especially true when the enthusiasm of would-be buyers is curtailed by rising interest rates, says Karl Case, the Wellesley College economics professor who is the co-creator with Yale economist Robert Shiller of the Standard & Poor’s/Case-Shiller home-price indices.

Housing prices in California nearly tripled during a five-year boom that ended in 1980, Case notes in a new paper posted Tuesday by Standard & Poor’s. When the boom ended, mortgage rates were between 16 and 18 percent. But instead of crashing, home prices stayed stable because nobody wanted to sell. Selling meant paying off your fixed-rate mortgage and getting into a new one at exorbitant rates, Case says.

An S&P/Case-Shiller home-price index that’s a composite of 20 major U.S. metro areas released yesterday showed price declines of 15.3 percent in April compared to the same month a year ago. On May 27, S&P/Case-Shiller’s separate national home-price index estimated a 14.1 percent year-over-year decline in U.S. home prices during the first quarter. That compares to a 2.8 percent annual decline at the height of the 1990-91 recession.

What’s different about the latest downturn?

Adjustable-rate mortgage (ARM) loans. During past downturns, people who bought in at the peak could choose to hang on to their homes until demand returned. The monthly payments on their fixed-rate loans didn’t go up.

But many who bought into the latest boom with ARM loans assumed that continued price appreciation would allow them to refinance before their interest rates reset and their payments went up. When prices stopped climbing, many were unable to refinance and their homes ended up in the hands of their lender.

Case’s explanation for the lack of price "stickiness" this time around is that when banks foreclose on properties, they don’t have the luxury of waiting for markets to recover. They need to cut prices to get properties off their books, fast.

"When a bank or other institution holding a property after foreclosure puts the home on the market, it wants to clear inventory and be out," Case writes. As long as foreclosure auctions continue to account for a significant portion of homes sales, "prices will continue to fall until the market clears. When it does, the traditional stickiness will return and prices will eventually stabilize."

Some in the real estate industry have speculated that the S&P/Case Shiller indices and the news media intentionally exaggerate price declines.

In their annual report on the state of the nation’s housing, experts at the Joint Center for Housing Studies of Harvard University note there are three major home-price indexes, all of which use different methodologies.

But after looking at all the indexes, the folks at Harvard concluded that national home prices were down 12 percent in the first quarter of 2008 from their October 2005 peak. After adjusting for inflation, that’s 18 percent in real terms. Ouch.

Since the messenger refuses to be shot, perhaps we should examine the message more closely.

While it’s a truism that "all markets are local," when you see how Case’s theory is playing out within metropolitan statistical areas (MSAs), you can sympathize with Realtors who distrust home-price indices — even as you see why their suspicions are misplaced.

In another paper posted by Standard & Poor’s, David Stiff — the chief economist for Fiserv Lending Solutions, the people who crunch the numbers for the S&P/Case-Shiller indices — looks at price trends at the ZIP code level within the Boston and Los Angeles MSAs.

Between September 2006 and the second half of 2007, the S&P/Case-Shiller index shows single-family home prices in the Los Angeles MSA falling by 8.9 percent.

At the ZIP code level, prices fell much harder — more than 15 percent — in many outlying suburban/exurban areas that were particularly popular with speculators. But ZIP codes near job centers in downtown and West L.A. experienced price declines of less than 5 percent. The pattern is even more distinct in Boston, where jobs are even more heavily concentrated in the downtown area.

Realtors have a right to be upset when their clients get the mistaken impression that media reports of national home-price declines pertain to their local market. What papers by Case, Stiff and two others recently published by Standard & Poor’s demonstrate is that you also have to take the numbers for an MSA with a grain of salt. They may overstate — or understate — price trends in a particular ZIP code.

"We all know that prices in neighborhoods within an MSA vary widely, but it may be that we need to consider that more closely when we think about an index at an MSA level," Stephen Bedikian, partner and research director at market analysis firm Real IQ, writes Inman News.

Bedikian raises another issue worth considering: If distressed property sales in outlying suburban and exurban areas are accounting for more than the usual share of sales in a given MSA, that could be distorting the price trends for the entire MSA.

"The index isn’t intentionally misleading but it is just a function of sales that occurred in a recent month," Bedikian writes. "For example, if 100 percent of sales captured in the index occurred in the Inland Empire one month, then the index reported for the Los Angeles MSA that month would be terrible despite the fact that prices held up nicely in Santa Monica and other areas."

What remains to be seen, however, is whether ZIP codes in major metropolitan areas that have weathered the downturn so far are merely exhibiting price stickiness. Although fewer properties may be ending up in the hands of banks, these areas may end up feeling the full impact of the downturn, but over a longer period of time. Areas where homeowners aren’t forced to sell may simply correct the old-fashioned way — slowly.

Instead of rapid price declines, property values in areas near job centers may fall gradually or stay flat for some time, just like back in the good old days.


What’s your opinion? Leave your comments below or send a letter to the editor. To contact the writer, click the byline at the top of the story.

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