by Calculated Risk on 9/20/2006 06:58:00 PM

In the comments to the previous post I suggested that Bay Area prices might fall 40%+ in real terms over 5 to 7 years. ac asked how I came up with that estimate, and Lester suggested somewhat impolitely that the estimate did not match my "moderate, professorial tone".

First, it's important to distinguish between nominal and real price declines. If the U.S. averages 3% inflation over the next 5 years - and nominal prices stay flat - real prices would decline 16%. Many homeowners would think they "broke even", when in fact the real value of their homes declined 16%.

Click on graph for larger image.

Lets look at the previous bust in California in the early '90s in real terms.

For the Bay Area and San Diego, median real prices declined about 25% over a six year period. In Los Angeles median real prices declined about 35%.

NOTE: Prices are from the OFHEO house price index adjusted by CPI less Shelter from the BLS.

If this bust is similar to the early '90s bust in California, we would expect real price declines of 25% to 35% over a 5 to 7 year period. I think this bust will be worse because I believe the current bubble was larger.

In real terms, prices in San Diego are already about 10% below the peak of last year. For the Bay Area, real prices are already about 4.5% below the peak. (based on DataQuick data).