Home Prices: The Next Leg Down

Although property values improved a bit in September, they may have an additional 10 percent to fall.

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Although home prices improved again in September, analysts predict property values will resume their decline in the coming months. The S&P/Case-Shiller Home Price report, which was released today, showed that seasonally adjusted home prices increased in September for the fourth month in a row. Prices are now roughly 3.5 percent above the lows they hit in May. At the same time, the third-quarter U.S. National Home Price Index dropped nearly 9 percent from the same period a year earlier. That's significantly better than the second quarter's 14.7 percent annual drop. But economists at Goldman Sachs argue that some of the recent strength in home prices is rooted in "transitory factors." And as a result, "we expect another leg down (5 percent-10 percent) as these wear off." Here are four things you need to know:

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1. Stabilization: Attractive mortgage rates have played a key role in the recent stabilization of home prices. Thirty-year fixed mortgage rates fell below 5 percent in early May from 6.08 percent a year earlier. At the same time, the price stabilization reflects the return of affordability to many parts of the real estate market. In the first half of the decade, the steep run-up in prices made properties too expensive for many consumers. But the real estate crash has pushed prices in many markets back down to levels that more Americans can afford. The first-time home buyer tax credit has also helped prod buyers off the sidelines.

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2. Unemployment: Still, there are several factors working to assert renewed downward pressure on home prices from here. First is the eroding labor market. The unemployment rate hit 10.2 percent in October and is expected to peak at around 10.5 percent sometime in 2010. With more Americans out of work or worried about losing their jobs, fewer will be eager to jump into the real estate market.

3. Foreclosures: Job losses will also hit home prices in another way. Unemployment is now the primary factor behind the nation's rising mortgage delinquency rate. The Mortgage Bankers Association reported last week that roughly 1 in 7 American home loans was either in foreclosure or past due at the end of September. And while the Obama administration's housing rescue may help some, a good chunk of these borrowers will end up losing their homes. Moody's Economy.com expects 3 million foreclosure sales to occur in 2010 and 2011. Those properties will add to the housing inventory and put additional downward pressure on home prices. "We are very worried about the potential for a huge wave of supply next year, both from private sellers and banks," Ian Shepherdson, the chief U.S. economist at High Frequency Economics, said in a report.

[See Why Foreclosures Rise Even as the Economy Expands.]

4. Transitory: Economists at Goldman Sachs argue that mortgage modifications, foreclosure moratoriums, and the first-time home buyer tax credit may have combined to juice home price indexes by about 5 percent in recent months. These factors, however, may prove to be transitory. "If so, as they wear off prices will probably drop again, though not as steeply as before," the economists said in a report. Patrick Newport, an economist at IHS Global Insight, said in a report that prices have an additional 5 percent or so to fall before hitting bottom.