Regional home price trends will be as diverse on the way down as they were on the way up. From 2002 to 2006, home prices more than doubled in 34 of the 381 metro housing markets and increased 12% or less in 12 markets, depending of the success of key local industries and the share of mortgages that would not have been approved before 2003 and after 2005. The price gains ranged from 7% in Detroit to 239% in Riverside, the eastern suburbs of Los Angeles.

Now the home price bubble is being reversed in cities where it occurred. And the recession is adding to home price declines. Nationally, the reversal of the price bubble is more than half complete in the latest metro data through the 3rd quarter. But since August, the mid-point of the quarter, price declines have accelerated as the recession deepened.

The 3rd quarter data put current home prices relative to the pre-bubble average in 2001in a range from -13% in Detroit to +109% in Honolulu. The price bubble still has some air in it in some metro areas but is fully deflated in others. Prices will substantially overshoot on the downside in metro areas with either the largest surplus of homes for sale or the largest negative impact from the recession.

Source: Freddie Mac

Generally, housing markets where 3rd quarter 2008 prices are more than 60% of the 2001 average have much more price decliner ahead. Housing markets where 3rd quarter 2008 prices are less than 30% of the 2001 average have little, if any, decline ahead from a deflating bubble but may have some recession driven decline. Metro housing markets in the middle where 3rd quarter 2008 prices are 30-60% above the 2001 average have some further bubble bursting or recession decline ahead but it is an orderly erosion of price not as price crash accompanied by mass foreclosures.

Metro housing markets can be divided into six categories with different home price trends in the next year.

Never Had a Price Bubble
Buffalo, Dallas, Houston and Louisville are representative of local housing markets that largely avoided the home price bubble and the ensuing bursting of the bubble. These cities will experience modestly weakening prices due to the recession although the recession is yet to arrive in Texas.

It Looked Like a Price Bubble But it Was Not
A few metro areas had above average home price appreciation in 2002-06 that was more due to real, underlying increases in home demand in previously stagnant markets. No bubble bursting occurred or is yet to come. Cities such as Caspar WY (natural gas), Bangor Me (casino) and Virginia Beach VA (the alternative to more expensive Florida) experienced a real rise in housing demand and hence prices — a one time up-shift in the home price index trend — that will persist as long as the original source of added home demand is sustained. Expect only modest further home price decline spilling over from the national recession.

What Goes Up Comes Down
Many housing markets in California and Florida experience 50% or more annual home price gains for several years due almost entirely to subprime mortgage that in retrospect should never have been approved. Second home speculation played a role in a few of these cities. This category includes all of the cities in the central valley of California, a few in southern California and Colorado plus all of Arizona and south Florida. The bubble is now completely burst in most of these cities but home prices will substantially overshoot on the downside because of the huge overhand of unsold homes and the desperate financial situation of local builders.

Speculation With a Dash of Subprime Mortgages
Boston, Chicago and San Francisco are representative of this category. Home prices rose significantly but largely due to strong local economic growth and supply constraints (no longer apply) on producing new homes. Modest population growth prevented a significant number of new home purchases with subprime mortgages. The latest monthly data show home prices rising again already in New England; resumed price increases in other cities in this category will come well before the national home price index turns up.

Speculative Bubble Not Yet Fully Deflated
Honolulu, New York, Washington, Miami, Los Angeles and Seattle represent this category. Home price are still substantially above pre-bubble levels even allowing for real, added demand in these prosperous cities. Strong local economies postponed the inevitable slide in home prices. More price decline is expected soon probably with overshooting on the down side. New York City is beginning to feel massive layoffs in the securities industry. Washington state and neighboring Oregon have just become the quickest declining economic region in the country as the recession has savaged all of their key export industries. The inevitable slide in Washington home prices may be postponed further if Obama brings a horde of new bureaucrats to town.

Secular Decline Aggrvatged by Recession
Detroit is the poster city for this category which also includes the auto manufacturing centers in Michigan, Ohio and Indiana as well as small manufacturing centers that failed to attract any of today’s high growth industries, such as Burlington North Carolina. Although home prices are already far below the level consistent with income and population, they will decline further for many months from the combination of secularly declining industries and the recession which impacts manufacturing centers more severely.

Home Price Index: % Change Q3 2008 vs. 2001 Average

Source: Freddie Mac and Reed Construction Data