Home Prices Plummet, Thank Goodness

Falling home prices could be just what the market needs.

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The National Association of Realtors existing home sales report for October—which was released Monday—is filled with ugly-looking numbers: sales fell 3 percent from September and nearly 2 percent from a year earlier. Total housing inventory increased to a 10.2-month supply. And the national median existing home price fell by 11 percent from a year ago—its biggest drop on record—to $183,000.

But painful as it may be, this drop in home prices isn’t bad news, it’s exactly what the market needs right now. The aggressive run up in prices that occurred during the housing boom put ownership out of reach for many would-be buyers. The market can’t recover until those buyers return, and sharp drops in home prices move the needle closer to affordability. “Ultimately, lower prices aren’t part of the problem, they are part of the solution,” says Mike Larson, a real estate analyst at Weiss Research. “It’s lower home prices that are going to bring buyers out of the woodwork and offset the tighter credit environment.”

While home prices have indeed fallen sharply since the bubble burst--they’re down some 20 percent from their 2006 peaks—they still have another 10 to 15 percent to go before hitting their long-term averages, Larson says. Barry Ritholtz, of the popular financial blog The Big Picture, called the price drop in today’s report a “Looks bad, actually is good” statistic. “Prices remain elevated, and the sooner they revert back to historic means, the better,” Ritholtz wrote in post.

Given the flat-lining economy, rising unemployment and tightening credit environment, it’s very possible that home prices overshoot on the way down just as they did on the way up. Larson says they could end up as much as 20 percent down from current levels. That means additional foreclosures for some and painful losses others. But home price drops like this one are essential—it painful—steps in the recovery process.