by guest author Peter Fugiel, Ph.D.

As the overall U.S. median home price moves back towards its forty-year average, coastal cities and high-price local markets will be at a severe competitive disadvantage. Dozens of local housing markets are already reporting slight price increases, or stable conditions, over the past three quarters.

These cities are mostly ’second-tier’ U.S. markets, which can reasonably be argued, comprise America’s “post-housing-bubble growth frontier.” Examples include Albuquerque, Austin, Baton Rouge, Birmingham, Charlotte, Columbus, Dallas, Dayton, Des Moines, Durham, Indianapolis, Kansas City, Little Rock, Oklahoma City, Philadelphia, San Antonio, Salt Lake City, Trenton, Virginia Beach and Wichita.

National Housing Prices Approach the Bottom

As the accompanying graph illustrates, the significant rise in U.S. home prices between 1999- 2005 had just about been corrected. Depending on the area, prices in many local markets either have adjusted – or will adjust -back to 1999 levels. Certainly the forty-year trend line shows just how strange the over-capitalization of home prices had been.

The Case-Schiller Index: A key twenty-market benchmark that tracks U.S. residential real estate pricing trends, has adjusted down by 38% since 2006. Some of the most speculative markets included in the index may still need adjustments. But then it has to be remembered: Some of the ’new unit’ markets in the index, like Orlando and Las Vegas, rose 100 percent in less than ten years.

In certain other index markets, like Boston and San Francisco, there are technical reasons why home prices are so high, and are expected to stay high. Either land is scarce, or building is prohibitively expensive. Prices in such markets have always been far above national price levels.

In some of the most over-financed coastal markets, new market-based banking remedies might be needed. High housing costs in California and unsold developer inventories elsewhere, pose serious challenges to local economies. The now well-known problems of once-favorite markets should not cause investors to confuse distressed local markets with the broad U.S. housing recovery.

The National Association of Realtors: The National Association of Realtors (NAR) median is a diverse, 146-market index. As such, it is a much broader median home price indicator. It is less affected by the peculiar problems of certain coastal and investor-oriented markets. The NAR median home price is down 30% since 2006. Actually, the NAR 2009 median home price now stands 3% below its 1999 median home price, as adjusted for inflation.

In addition, well more than half of all the local markets included in the NAR statistics are currently reporting median home prices below the national level. That includes 82 markets in dozens of states. These are markets that were never all that popular, either with investment banking products or federal enhancement guarantees.

Sales Volume Returns to Pre-Housing-Bubble Levels

The NAR ten-year trend in home sales: One key benchmark that realtors watch, (that the capital markets usually don’t interpret) is the volume of home sales. Nationally, the level of home sales has come back significantly since 2007. In 2009, national home sales were close to the 1999 level, at around 5.5 million. In a capital market with as many transactions as there are in real estate, sales volume is an inescapable index of market health. And of course, the higher the sales volume, the more likely prices on preferred units at least, will find their post-bubble price levels.

Pronounced Sub-Market Differences

In a seller’s market, prices of all kinds of units tend to rise simultaneously. In a buyer’s market, only certain units are favored. A buyer’s market pecking order sets in, and prices rise only on the most favored unit types and with the best locations. So for example, in the huge Chicago metro market, this is the emerging pecking order. The best located center city condo units have tracked well throughout the recession.

Well-located suburban homes in the best school districts have begun to rise in value. In all locations, it is detached, single-family homes that are heavily favored over attached condo and town home units. Sound units in distressed areas are priced way below their value. Vacant “spec” and unsold developer inventory have lost the most value, second only to ’distressed’ units including lender foreclosures, short sales, and any auctioned property, of whatever type.

But no two U.S. metro areas will be the same. Whereas Chicago has a well-developed downtown condo market, suburban homes are still the preferred unit in such big markets, like Indianapolis and Houston. And despite the media’s fixation on city-to-city price differences, sub-market differences within individual metro markets, will be the big story after the housing bubble. But you have to know a local market well enough to see what profound price differences are beginning to occur.

U.S. Government Approves Restrictive Appraisal Process

The big loser in the post- bubble economy will be lenders with large distressed property inventories. Just as a variety of local housing markets around the country are on the mend, there is a new challenge to stabilizing markets. The appraisal process is being dictated by a Washington-based, one-size-fits-all mentality that fails to rely upon savvy local professionals.

Local, private-market participants may not be able to save the seriously over-leveraged lender inventory, but they can certainly help make the necessary distinction between market-based values and fire-sale write downs. Everyone within the gigantic U.S. housing industry should be able to make the stats-based distinctions between private-market prices and bad loan sell-offs. Good and bad units exist in the same markets – and they cannot be confused with each other. They should not be confused in so-called ’comp’ studies that determine value.

The ’Reformed’ Appraisal Process Misses the Mark

There should be a genuine concern if home appraisers are paid less – and their management companies are paid more – than in the previous ’up’ markets. The danger is that ’turnaround time’ will become more important than local expertise. These changes in the appraisal process are supposed to correct former lending abuses.

However, as many U.S. local markets return to their usual private-market routines, one of the key players in these markets has been missing. The appraisal process has become a standardized, centralized process that appears to be missing the main point in the adjusting markets. For those residential units where there is an arms-length transaction between a buyer and a seller, there should be good market data to show that the agreed upon price is market-based. Appraisers may not know the local market as well as the parties to the transaction. And it is easy to confuse marketable units with sell-off properties.

Without some kind of recognition of local market expertise on the part of the appraisal process, we are all going to be making valuation mistakes, again. Only this time the temptation will be to under-value units, because it is a ’down’ market. The capital markets have to give the real estate professionals credit for what they do best. Good units are going to increase in price, and bad units are going to decline in value. That is two markets in one area market.

It is never an entire local market that is good or bad. Rather, quality distinctions made by buyers, within the local market, must be recognized. Otherwise we are back to a kind of ’red-lining’ – only this time one based on a less-than-knowledgeable appraisal methodology.

About the Author:

Peter Fugiel has followed the national housing markets for 31 years. Peter has conducted extensive inter-market, inter-local, and sub-market housing research for the past eight years. His specialty is using realtor trade group statistics to monitor sub-market trends, including analysis of the ’value pecking order’ that is emerging in buyer-driven local markets. Peter holds a Ph.D. in government and is a public finance/housing consultant in Chicago.