The message was clear during housing analyst Ivy Zelman's presentation this afternoon at the NAHB's Fall Construction Forecast Conference: Fasten your seatbelts. As if the ride for home builders hadn't already been bumpy.

About the most positive thing in Zelman's outlook for housing was that the decline in home sales should bottom in 2009. However, she anticipated that real home price declines would persist through 2010, delaying a return to more normal housing conditions until sometime between 2012 and 2013.

When it came to sales in the new-home market, she said, "Current trends are pretty frightening."

In July and August, banks started releasing REOs en masse into the market, moving quickly to get them off their books rather than pay anywhere from 1.0% to 1.5% percent in holding costs. Those foreclosure sales, often at fire-sale prices, became stiff competition for home builders. Consequently, new-home orders suffered. Zelman estimated that, within the public builder group, new orders for 2Q2008 fell by roughly 43%. And it's gotten uglier, she said.

"September trumped July and August, which we didn't think was possible," Zelman said. "And then we saw October."

She used current order trends for Las Vegas as an example. She estimated that Las Vegas had roughly 350 actively selling communities in the market, which normally clock between 600 and 700 sales per month. In October, she said 60 homes had been sold. "That's basically zero," she added.

Although Zelman noted improving cancellation trends in 2Q2008, she predicted cancellation rates as a percentage of builders' backlogs would jump in 3Q2008. With foreclosure sales "the only game in town," she said, appraisals on new homes would continue to come in below contract price, forcing builders to either lower the price on the homes, creating significant backlog risk, or cancel the sale.

The pressure on pricing has dropped new home prices 13% from a peak in 1Q2006--to 2004 levels. Zelman predicted a total new-home price decline of 20% from peak to 4Q2008.

Price declines have been more extreme on the land side of the business, with a median price drop on finished lots, excluding liquidations, at 45%. "It's more disconcerting for raw ground," Zelman noted, explaining that, in many markets, raw land was selling for below improvement costs.

And with the squeeze on land values expected to continue, Zelman estimated that home builders still have another $6.5 billion in land-related impairments left to recognize. However, home builders have been cutting deep as they mark their assets to market; Zelman's analysis showed that builders were taking, on average, a haircut of 44% on their purchase prices.

But even in this era of going asset light--essentially reducing land exposure--Zelman pointed out that some public builders were facing a "big conundrum" vis à vis a diminishing supply of finished lots.

"At some point they have to put a shovel in the ground," Zelman said, "or invest cash in new options."

However, without much market improvement expected over the next couple of years, many of those builders could be looking at liquidity issues cropping up at a time when they need to reinvest in their businesses. Moreover, as bank lines come up for renewal in 2010 or 2011, banks may elect not to renew builders' capital life lines, she said.

Land value deflation and slowed cash generation have delivered a powerful one-two punch to builders, causing many to have trouble paying their acquisition and development (A&D) and construction (C) loans. Nonperforming AD&C loans have accelerated since 2007 but currently account for 6.1% of total loans, thanks to banks' interest reserve cushions and loan workout programs, according to Zelman. Not too bad, but not for too long.

"That 6.1% pales in comparison to what's coming," Zelman said.

More nonperforming loans would put more stress on banks, continuing the vicious cycle of credit tightening. Zelman said many banks were holding out on appraising nonperforming AD&C loans because they had insufficient cash reserves to absorb the expected charge-offs; her research showed that roughly one out of three banks had completed new appraisals on their nonperforming AD&C loans.

And Zelman expected that the industry-wide charge-offs will be big. Zelman said AD&C loans tallied roughly $700 billion, or 8.6% of all bank loans--the highest level in at least 30 years. Related charge-offs should reach $100 billion or more, Zelman said.

For Zelman, this added up to constricted access to capital for builders. She expected the number of AD&C loans would shrink 3% in 2008 but expected more serious contraction going forward. At the bottom of the housing downturn in the early 1990s, outstanding AD&C loans had shrunk by 23%. "I expect that it will exceed 50%, given that this cycle is much more severe," she explained.

But for the dismal outlook, home builders will not be alone in their misery for long, Zelman said. Building product companies and commercial developers will provide much company as weakening in nonresidential construction becomes the "next phase of this perfect storm." The number of nonresidential new projects, which has kept product companies from a free fall, has fallen in 2008 as financing troubles spilled over into the commercial market.