When will the housing market rebound?

I was recently asked by Beacon Economics and the State of California Controller's Office to write an article on the timing of a housing rebound for their monthly Summary Analysis Report, a .pdf of which you can find here. Here are some excerpts:

Following multiple months of dire news on California’s housing market, more recently a combination of factors are starting to show the beginning of stabilization in the state which has practically defined sub-prime lending gone sour and greedy speculators reaching beyond their means. While the real estate market is certainly still bad – and is likely to remain so through the end of 2009 – there are some definite signs of hope for 2010 and beyond.

First, the bad news. After a temporary dip in foreclosures during the last quarter of 2008 due to moratoriums and procedural changes in the way lenders handled loan defaults, by February of 2009 the combination of default notices, auction sale notices and bank repossessions in California rose to nearly 81,000 properties – the most of any state and representing a 5% increase from January.

When compared with February of 2007, foreclosure activity spiked up by 51%, with auction sale notices alone skyrocketing by nearly 180%. And, whereas the percentage of loans in California entering foreclosure had been far less than those for the overall country as recently as the first quarter of 2007, by the end of 2008 the ratio had flipped, or 1.36% (California) versus 1.01% (U.S.). Furthermore, the ratio for loans already in foreclosure in California leapt from just 0.17% in the middle of 2005 to 4.19% by the end of 2008 – nearly 100 basis points above that of the U.S. (3.3%)...

At the same time, no matter how many incentives home builders pile onto sales contracts – estimated by one of the country’s largest public builders to exceed $50,000 – they’re still finding it almost impossible to compete against substantially discounted existing homes, over half of which are foreclosures...

Even with pricing declines of $100,000 from the 2006 peak to under $350,000 for a new home by the end of 2008, that median sales price was still nearly $100,000 higher than for both existing single-family homes and condominiums. Consequently, sales of new homes have continued to steadily decline, reaching just over 10,000 units in the fourth quarter of 2008 – a drop of 73% since the peak reached during the second quarter of 2006...

Still, there do remain a couple of wrinkles for a sustained housing rebound. One is that banks, wanting to avoid further depressing prices, have been sitting on foreclosures and only doling them out to the marketplace in small amounts. Should they release a larger group of properties at once, prices could fall further – although that could encourage even more buyers to snap up the new discounts...

Another concern is the much-heralded S&P/Case-Shiller Index, whose primary flaw (like all housing indices) is its inability to accurately gauge the quality of its paired home transactions. For example, if a home that sold at the peak of 2006 sells again as a gutted, semi-destroyed foreclosure in 2009, the decline in value speaks more to structural changes in the home itself than an accurate reading of the local marketplace. Consequently, some critics contend that this index can over-state swings in the marketplace -- especially price declines -- and magnify equity losses in areas with greater foreclosures...

Yet even the Case-Shiller Index is showing a flattening of price declines, and that’s because buyers are starting to show up with visions of low mortgage rates and potential positive cash flow. Finally, as the programs initiated by Realtor groups, home builders, and the federal government begin to gain traction -- and as lenders have learned which loan modifications work best --we may see a slowing of foreclosure activity and a rebound to a more market-based housing market sooner rather than later. But patience is still warranted.