Home builders learned the hard way about how to clear an overbuilt market. Drop prices and trim production until new-home sales find a new equilibrium. Builders have been taking their lumps as they struggle to restore market balance.

Eric Belsky Not so for existing homeowners–yet. Most existing home sellers are still waiting to see if they can get their price. Many sellers won't budge unless they have to. Only sellers who have lost their jobs, got a divorce, or have changed jobs are under pressure to drop their asking prices. In the absence of job loss or a wave of foreclosures, there are just not enough urgent existing home sellers to drive down market prices right away.

Existing home prices are historically stickier than new-home prices when markets soften.

Pricing Pressures

But prices on the existing home side can only defy gravity for so long. The months' supply of existing homes for sale is well above the six months thought to divide a buyer's from a seller's market. Motivated home sellers have reluctantly started to lower their prices. As a result, broad measures of existing house price changes such as the National Association of Realtor's (NAR) median existing home price and the Case Shiller Weiss repeat sales index show prices down on average nationally by roughly a couple of percentage points from a year ago.

It is tempting to conclude that the reason for these price declines is that prices soared so high in 2004 and 2005. But existing home price corrections in the nation's largest 75 metropolitan areas have been caused far more often by overbuilding, especially when combined with job loss, than by price overheating alone. Not one of the 35 large nominal house prices declines (over five percent) in these markets, from 1980?1999, derived from severe overheating alone. But three of them were associated with a spell of severe overbuilding alone.

Severe price overheating occurred in the absence of either at least moderate overbuilding and job loss only eight times prior to 2000. House prices fell in just two of these instances. But severe overbuilding occurred in the absence of overheating and job loss eight times and in fully half of these instances a price decline occurred. Throw in minor job loss to the severe overbuilding mix and it led to existing house price declines in all but one of the 15 times it occurred.

No Fast Rebounds

Now that existing home prices have started to correct in about four out of 10 markets covered by the NAR, strap yourself in for a prolonged period of pricing pressure. Historically, when existing prices start to fall in severely overbuilt metropolitan areas it usually takes several years before they bounce back. The median length of the 18 house price declines in severely overbuilt markets that occurred from 1980-1999 in the top 75 metros was five years.

Job loss prolongs price declines in severely overbuilt markets. The four times that prices fell around periods of severe overbuilding and modest job loss (five percent or less), prices fell in three of these instances for five years and in one instance for six years. Of the 10 times prices fell around periods of severe overbuilding and major job loss (five percent or more), two times the price decline lasted seven years, four times it lasted six years, and two times it lasted five years. That's tough sledding.

Thus, during this downturn, few metro areas have experienced job loss but many look like they are severely overbuilt. Using a measure of overbuilding that includes single- and multifamily permits, about 20 of 361 metros may have been severely overbuilt by 2006. Using one that focuses on single-family building only, however, 53 metros may have been. Let's hope these places are spared job loss before builders pull back on production and drop prices to bring them back into balance.