Home prices are declining again. Although the home buyer credit delayed their descent for a while, you can't keep an overvalued market up forever. How much farther can we expect prices to fall? One way to determine this is to look at the historical trend.

So here's a chart by from Robert Shiller, updated by Steve Barry, via Barry Ritholtz's the Big Picture blog:


This chart is up-to-date as of January -- that's the thick black line. The red dotted line is a presumed trajectory to get back to the historical norm. Assuming that prices will eventually settle somewhere between 100 and 110 on the chart, then the index must fall between 30 and 40 points. That means we can expect about another 21% to 29% decline in home values.

There are a few things to keep in mind about this assertion, however.

Hyper-Local Markets

First, the housing market is hyper-local. Some states will fare better than others; some cities will fare better than others; some parts of a town will even fare better than other parts of the same town. Housing prices will not fall everywhere by another 21% to 29%. In some places they'll fall by more; in other places they'll fall by less; in different places they will rise or remain flat.

A Long, Slow Descent

Second, it's unclear how long this process will take. Home prices only fell 1.3% in the first quarter. That's not a lot, considering they likely have at least another 20% to go. There are several factors in the market keeping prices artificially high.

Foreclosure Backlog

Banks are processing foreclosures slower than ever as they grapple with getting their procedures right. That makes the inventory buyers see look smaller than the giant pool of defaulted homes that actually exists. If this inventory was all visible to the market at once, prices would bottom out quicker.

Ultra-Low Interest Rates

Interest rates remain near historical lows. They make homes appear relatively cheaper to buyers. Until mortgage interest rates begin to rise, mortgage buyers will be willing to pay relatively more for a home, because they can afford a higher price. When that changes, prices will have a harder time staying as high.

Mortgage Modifications

Tens of thousands of mortgage modifications occur each month, saving homeowners from foreclosure. A large portion of this relief is probably temporary, however, prolonging the inevitable. Probably at least half of these loans will re-default in a year or two. This effectively delays tens of thousands of homes from hitting the market each month, again keeping prices higher for the time being.

Real vs. Nominal Prices

Finally, don't forget that we're talking about real prices here. The chart above corrects for inflation. As just explained, housing inventory will likely be elevated for several years, as defaulted properties slowly hit the market. During that time, inflation is likely to be at least a few percentage points higher than it has been over the past few years. So if inflation is 4%, and home prices are flat, then real prices really declined by about 4% that year. In fact, even if nominal prices increased by 1% that year, real prices would have declined by 3%.

So even if home prices appear to be rising again in a year or two, they might continue to decline towards the historical norm, in real terms. Unless prices rise faster than inflation, they're actually falling.

What's it all mean? Even if the housing market appears to stabilize in coming months, home values will not likely recover for several years. Eventually, the market will hit a firm bottom, and homes will again resume appreciating at about the rate of inflation. But from the chart above, it's pretty clear that prices have quite a bit more pain to endure.

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