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Home prices have been falling for several years and inquiring minds want to know if the pain is going to end. Of course, a home owner’s pain is a home buyer’s gain, but I digress. At his excellent blog, Calculated Risk (link below), Bill McBride shows a chart covering two sources of data on home prices. Based on the data going back to 1976, it looks as though we are near the bottom in terms of price.

If you take a look at the chart (click to enlarge), two things will no doubt jump out at you. First, the absolute magnitude of the real estate bubble is the most obvious point. But second, we can see that prices have fallen far enough that we are approaching the historical trend line as shown in the chart below.

Source: Calculated Risk

In the chart, there are two streams of price data on homes — S&P / Case-Shiller and Corelogic. From the post accompanying the chart, here is the explanation [emphasis added]:

…The … graph shows the upward slope for both real price indexes. Even the Shiller Irrational Exuberance real price index has an upward slope – and the CoreLogic upward slope is steeper.

…Right now the real CoreLogic HPI is less than 5% above the trend line (it could overshoot), and the Case-Shiller national index will probably decline sharply in Q1 too and not be far above the trend line.

…Prices might overshoot to the downside because of supply and demand issues; there is a large overhang of vacant housing units and many distressed properties still coming on the market, plus demand is soft with weak employment, fairly tight financing, negative home buying sentiment and some usual buyers excluded because of credit issues. But I don’t think national real prices are that far out of line.

Note: usually near the end of a housing bust – after nominal prices stop falling – real prices decline slowly for a couple more years, and we will probably see that this time too. Of course, right now, nominal prices are still falling.

After seeing the chart, I emailed Calculated Risk to find out what the annual percentage rate of increase has been in the two measures of home prices. The S&P / Case-Shiller average has gone up at 0.2% per year and the Corelogic rate of increase has been 0.8% per year or slightly less than 1% per year. In other words, in the aftermath of the bubble, price increases per year have been modest indeed.

Home prices, George Soros and reflexivity

The point made above about overshooting is a good one. In hindsight, we know that prices overshot on the upside and went far above the historical trendline. Therefore, it is reasonable to suggest they might overshoot and fall below the trendline too.

This is a common market reaction. In his book, The Alchemy of Finance (Simon & Schuster, 1987), George Soros described market activity as being an example of reflexivity. With stocks or real estate going up, more and more folks enter the market and, in turn, their buying moves prices higher. Risk is not a big factor in the buying decision. Think of the mood about real estate in 2005 or technology stocks in 1999. Eventually though, all potential buyers are on board and then the flip side takes over. Reflexivity also works on the way down because falling prices beget more selling and prospective buyers decide to delay buying so prices fall further.

Government interventions in the housing market have failed to stem the ebb tide for prices. So far, we have not hit what is known as a market clearing price. That is, the price at which bargain hunters move in and snap up what they see as bargains. We are beginning to see buyers move in, but the number of unsold homes is still very high.

Though we may be close to the end of price declines, the last part may be very difficult. This is because the process of getting to a ‘market clearing’ price is always messy and painful. For example, think back to the stock market lows of March 2009. That was not a time when it was easy to hang on to stocks much less to add more. So it will be as we approach the bottom in home prices. We are likely to see very negative news and sentiment in terms of homes. However, that is a necessary part of the bottoming process.

See also: Zillow.com reports major real estate woes

Source: How Far Will Home Prices Fall?