How Bad Will the 2007 Property Market Be?

Economists predict that next year will be tough, but some metros will hold up nicely and the future may not be as gloomy as some fear

As the real estate sector softens, many new homes are going unsold. But that means more opportunities for buyers. Getty Images

by Maya Roney

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Americans are increasingly nervous about the real estate market in 2007. They have good reason to be. But the news isn't all bad: Interest rates will remain at historically low levels, homebuyers will see more opportunities, and, best of all, for those planning for the long term, 2009 could be primed for a comeback.

To gauge what the next 12 months might look like, though, BusinessWeek.com asked economists at leading real estate research firms to provide their outlooks for the housing market in 2007. The less-than-festive consensus: Home prices will continue to fall in some markets, and the rate of price appreciation will slow in most places. Declines in homes sales, which directly influence price trends, will set the stage for another year of price decreases in 2008. Foreclosures will continue to increase. For those struggling to hold onto their homes, their net worth will shrink as these homes lose value. Long-term mortgage rates will rise. Housing starts will see double-digit depreciation, the sharpest decline since 1991, the worst year for housing starts on record.

Grim as that might sound, there are some bright spots. Nationwide, home prices will be flat to up slightly in 2007, with many large markets seeing small increases. While new home sales will be down for the year, existing home sales will also be flat. And housing starts won't see as sharp a decline as they did in the early '90s or early '80s.

Self-Cleaning Market

Another reason for optimism (keeping in mind that expectations are somewhat lower this year): For many, the ongoing market correction will make the dream of buying a home a reality.

"In so many of these markets, housing became extremely unaffordable," says David Stiff, chief economist at Brookfield (Wisc.)-based financial data processor Fiserv Lending Solutions (FISV), who expects average U.S. home prices to appreciate only 0.1% overall in 2007. "Prices moving back in line with household income sets the stage for price appreciation in the future."

Blame the rapid runup in prices on speculation. Taking advantage of low interest rates and good economic conditions, investors drove prices to new heights in the first half of the decade, so they could flip purchases for profit. Some markets saw price appreciation rates of as much as 50%, vs. the average annual rate of about 10%.

But as interest rates rose and the gap between income and housing costs widened, homebuyers never materialized as expected. Investors have now been forced to dump their property on the market, flooding many places with homes for sale and forcing prices to a more realistic level.

Time Lag

"The market was in a frenzy in 2005," says Lawrence Yun, senior economist at the National Association of Realtors (NAR). "The current transition is just cleansing away the speculators." Yun expects existing home sales to slip just 0.6% in 2007, with a pickup in the fourth quarter continuing into 2008.

Home price trends tend to lag 9 to 12 months behind sales trends, according to Stiff, who predicts prices will be weakest in 2008 and rebound in 2009.

The researchers at Fiserv arrive at their price forecasts by first estimating what home prices would be if housing supply and demand were in balance—that is, if price levels were consistent with local demographic trends and household-income levels. They then look at the difference between the estimated "equilibrium" price and the actual price level. If prices are too high relative to the affordable, equilibrium level, the forecast is weaker price appreciation. If prices are much higher than equilibrium, the model forecasts price declines.

Construction Diet

This explains why former red-hot markets like Southern California, Florida, and Las Vegas, which saw the most rapid runup in prices between 2001 and 2005, will see the sharpest declines in prices in 2007. The Miami area, with an estimated decline of 9.16%, will have the second-worst 2007 price drop out of all the country's metro areas. Las Vegas comes in third-worst overall, with a 9.15% forecast decline, and Los Angeles, with a 7.1% decline, isn't too far behind.