Buying and Selling in Tough Times

So, where the heck is this bottom? The question is stealing sleep from weary homeowners who have watched home prices plummet 21 percent from their 2006 peaks, evaporating more than $2 trillion in wealth last year. Meanwhile, government officials, who witnessed the U.S. housing market's collapse tip the global financial system into chaos, are scratching their heads for answers. Yet the numbers keep heading south. How much more pain can this market dish out?

Trouble is, despite the already precipitous declines, home prices aren't expected to bounce back anytime soon. Actually, a slew of unsettling developments—the ongoing recession, tighter credit, and the massive glut of unsold inventory, just to name a few—suggest values have farther to drop. "I think it will be probably mid-2010 before we see the bottom in home prices," says Mission Residential's chief economist, Richard Moody, who expects values to fall 10 to 15 percent more before stabilizing.

Could the market spring back to life before then? Perhaps. Cheap mortgage rates, which hit record lows in January and are expected to remain attractive, are the best reason to hold out hope for an earlier-than-expected rebound. "Low interest rates are a very powerful tonic for housing markets," says Kenneth Rosen, chairman of the Fisher Center for Real Estate and Urban Economics at the University of CaliforniaBerkeley. But as banks jack up their lending standards in the face of higher delinquencies, many would-be homeowners won't qualify for the most attractive rates, blunting the impact of this incentive.

But for a housing market that grew wildly overvalued during the first half of the decade, lower prices are just what the doctor ordered. By August 2005—as the real estate boom approached its crescendo—median home sales prices had swelled to nearly four times Americans' average after-tax incomes. That's way too expensive for most Americans (median home prices in healthy housing markets typically cost less than three times incomes). The housing market can't come back until affordability is restored, and that's just where crashing home prices come in.

By November 2008, the historic drop in property values had already whittled median home prices down to just over 2.5 times incomes—pulling this key ratio below levels you'd see during periods of stability. "This is how you correct overvaluation," says John Lonski, managing director of Moody's Capital Markets Economics. "Even though it's very painful, you're moving home prices in a direction that enhances affordability and lessens the risk of another big slump."

The problem, however, is that home prices are likely to go overboard on the way down, just as they overshot on the way up. Even as houses get cheaper, buyers may be scared off by gloomy unemployment figures or painful memories of the bust. Meanwhile, others won't qualify for loans. In order for housing to stabilize, prices have to get low enough to pull buyers—as a group—back into the market despite these fears (lower mortgage rates will also help). Lonski expects prices to bottom in the spring of 2010.

Amid lower prices and cheaper mortgage rates, 2009 will present plenty of opportunities for would-be home buyers. But with the economy mired in what may turn out to be the nastiest recession in decades, anyone purchasing a home this year should proceed with caution. Here are five things to consider before deciding whether or not to jump into the real estate market in 2009:

Buying a Home

1. Make sure your financial house is in order: Perhaps the biggest concern about buying a home during a recession is that you may lose your job shortly after closing the deal. As a result, if you're thinking about purchasing a home this year, you should do so only if you have solid job security. In addition, banks have been raising their lending standards in the face of higher delinquencies. That means most would-be home buyers will need a FICO score of roughly 720, a down payment of at least 3.5 percent, and documented income verification to get the best mortgage rates, says Keith Gumbinger of HSH Associates. "Mortgage money is available," Gumbinger says. "However, you are going to have to align yourself more closely with the new, more prudent lending standards."

2. Buy a home, not an investment: A lot of people got hurt in the housing bust because they bought homes as short-term investments. With the market expected to decline further this year, 2009 won't be a good time to get back into real estate flipping. You're better off buying for the long haul. "If you're not planning on living in that house for more than three to five years, I wouldn't buy anything right now," says Richard Green, director of the Lusk Center for Real Estate at the University of Southern California.