Real Estate November 23, 2009, 9:20PM EST

Checking the Health of the Housing Recovery

Waiting for the pain in residential real estate to end? BusinessWeek asked experts what to watch now

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There are yet more signs that the crippled U.S. housing sector is getting back on its feet. On Nov. 23 news arrived that U.S. existing home sales jumped 10.1% in October. Homes were bought and sold at the rate of 6.1 million per year—much better than the 4.5 million rate in the beginning of the year. More data are expected in coming days on home prices and new-home sales.

"We've seen some more encouraging data [on] the housing picture, but we're not out of the woods," says Michael Sheldon, chief market strategist at RDM Financial Group. The challenges remaining for residential real estate include the many foreclosed homes moving onto the market, a large inventory of unsold homes, questions surrounding the federal government's efforts to stimulate housing sales, and broader economic weakness that saps Americans' ability to buy.

So what signals could demonstrate that the housing market has real strength? BusinessWeek asked economists and housing experts which indicators they're watching closely.

Housing Inventory

As with any market, the balance of supply and demand matters in real estate. And that balance is still out of whack, but it is improving. In October the equivalent of seven months' supply of existing homes were on the market, down from eight months in September.

"We're showing signs that we're clearing out the excess inventory," says Michael Strauss, chief economist at the Commonfund, but inventories are still high. A more normal level would be 5.5 to 6 months, he says.

One good sign is that homebuilders seem to be adding very little supply, with new-home inventories at their lowest levels since 1982. "All the unsold stuff is starting to get liquidated," says Michele Gambera, chief economist at Ibbotson Associates, a subsidiary of Morningstar (MORN). "But there is still so much that has to be sold before the market has a semblance of normality."

Home Prices

Home prices remain depressed but may have hit bottom. The median sale price of an existing home in October was down 7.1% from a year ago, better than the 8% year-over-year decline in September.

When the weather gets warmer in spring, home buyers come out of hibernation and housing prices often move higher. The spring of 2010 may be the market's best hope for a significant upswing in home values—the first in more than three years, says Michael Englund, chief economist at Action Economics.

"If the story is out that we're seeing big increases in price, that will be an encouraging sign," Englund says. That, in turn, could give a big boost to the psychology of the housing market and to the mindset of Americans who have so much of their wealth tied up in their homes. "We need the housing market to stabilize because it is such an important component of household wealth," says Jerry Webman, chief economist at OppenheimerFunds.

Hidden Supply

Economists and real estate experts are grasping for any indication of how much "hidden supply" is out there waiting to come to market. First, there are home buyers who would like to sell but are waiting for better market conditions. Second, there are foreclosed homes in the process of being seized and sold by banks. Both are difficult to measure or predict. "There is all this shadow inventory building up," says Mike O'Rourke, chief market strategist at BTIG. "The banks are so overwhelmed, it takes forever to work it out."