by Calculated Risk on 6/15/2006 06:29:00 PM

Harvard's Joint Center for Housing Studies last week released a new report on housing: State of the Nation's Housing 2006. The report suggests that a "soft landing" is likely for housing, mostly because other factors are not present (loss of employment and overbuilding).

... when and if house prices do fall, the so-called bubble is more likely to deflate slowly rather than burst suddenly. History suggests that appreciation eases for a year or two before prices come down in nominal terms. While dips of a few percentage points are common, nominal house prices rarely drop by 10 percent or more.

Still, over the past 30 years, nominal house prices have in fact fallen by five percent or more at least once in about half of the nation’s 75 largest metros. In most cases, it takes significant job losses—or a combination of overbuilding, modest job losses and population outflows—to drive house prices down substantially. In terms of magnitude, price declines associated with episodes of major job losses alone average 4.5 percent, while those occurring in and around periods of overbuilding alone average 8.3 percent (Figure 11).
emphasis added

Click on graph for larger image.

Figure 11 shows historical price drops associated with minor and major job loss and overbuilding,

However, one of the co-authors of the Harvard study, Rachel Drew, was quoted in Business Week: A Soft Landing for Housing?

Drew notes that the Harvard study was based on the state of the market at the end of 2005 and admits her optimism has been tempered a bit by the slowdown that's occurred so far this year. "The first-quarter numbers showed the housing market slowing a little faster than we expected," she readily admits. But for the most part, she stands by the conclusions of the report.

Overall I think the Harvard study is reasonable, however I think the price declines will be more significant than JCHS expects. There are several reasons for my pessimism: 1) Housing is now a larger portion of the US economy than in previous periods. So a housing slowdown will have a larger ripple effect on the overall economy. 2) As noted in the report, homeowners have been extracting equity from their homes to maintain their lifestyles. As housing prices flatten out and start to decline, this mortgage equity withdrawal will slow, impacting consumer spending. and 3) there has been significant speculation and the use of leverage to purchase homes in recent years (the exotic or nontraditional loans). This will probably lead to more foreclosures and lower prices.

As Harvard noted: "[historically] appreciation eases for a year or two before prices come down in nominal terms". What Harvard didn't add is the nominal declines are historically slow and steady over a multi-year period.

“Actually, what we are seeing is a very typical slowdown in the market so far—there is nothing particularly soft about it (the landing in bubble markets). The claim is that because unit sales are falling but prices are still going up, that this is an unusual slowing. The fact is that most breaking markets start with activity, and it takes three to four quarters for that to take all the wind out of price appreciation. How hard it will be, remains to be seen.”

UCLA's Dr. Christopher Thornberg (from Smart money is leaving the real estate market)