The old joke was you knew the housing market had hit its peak when you attended a party and the primary discussion centered on how much money everyone was making selling and buying homes. Today’s cocktail chatter is about losses and value declines since the 2005 peak.

The discussion’s centering point remains on the numbers, which show a year-to-year decline in prices of 7.8 percent through September. While quite poor in some parts of the region, prices are fairly good elsewhere.

For example, in the North Coastal market between Carlsbad and Pacific Beach, extending about 1.5 miles east of Interstate 5, average prices in the three months ending Sept. 30 were up, rising from $1.07 million to $1.16 million ($490 to $529 per square foot). The number of sales was down 64 percent — 213 compared to 590 — suggesting only the more marketable homes are selling.

More contradictions are revealed by further parsing this market into distinct home-price categories: $400,000 to $800,000, less than $1 million, and more than $1 million. On a price-per-square-foot basis, each category has increased. This data also show greater sales activity for homes valued at more than $800,000, suggesting less demand for cheaper homes.

Is The ‘Outlier’ Inevitable?

Drawing long-term conclusions from general data can be unwise. In statistics, the term “outlier” refers to a value that is far from most others in a set of data. Speculation on the recovery is reaching the point of silliness when it becomes accepted that the outlier, in this case a tremendous decline in prices, is inevitable. Yes, there is a chance the very large gap between median income and median home price (in San Diego the price now is 9.1 times income, well above the more normal four to six times range) has to come back down to this more normal range. The theory goes that because it is unlikely that incomes will rise quickly, it is more likely that home prices must inevitably drop quickly.

Serious commentary has appeared in the local media, suggesting home prices will drop 50 percent.

What this argument misses is that the income to price gap is rarely the determining factor. Simply put, most transactions in San Diego County are “move up” — consumers trading up to a more expensive home. They are not starting fresh, using only their income and a minimal down payment. Typically, a homeowner sells for a profit, using those dollars to buy down the financing costs of living in a nicer home. It is not unusual to see this transaction happen several times in the life of the average San Diego homeowner, and indeed income from such deals helped fuel Downtown’s residential boom.

For the foreseeable future, the price-to-income ratio will stay above historical standards because financing will remain relatively inexpensive (compared to the last 30 years). In the long-shot chance the rest of the world loses faith in our economy and stops buying T-bills, then financing will undoubtedly become more expensive. Yet even in past times of high interest rates, San Diego’s ratio was not in line with what is considered normal. If the entire U.S. economy falls into a significant recession, however, the problems will be much more severe than just housing values.

Market Disengagement

Most people are not engaged in the market. The number of transactions through October was 21,000, compared with 29,000 the previous year, meaning the county won’t see half the 60,000 transactions experienced during more robust years.

This much smaller field also is heavy with distressed transactions, folks who must at all costs sell a home, or who already are seeing it sold by the bank. Do we really want this bubble group to define our housing values? Well, yes, that is exactly who rules during this point in the cycle. Those who want no part of that crowd will sit on the sidelines, wait for a settling and not transact until they sense that the market has settled. Here is what consumers will see as the settling factors:

• The variable note readjustment cycle ends. This is likely to take another year as all the “teaser rate” loans written during the 2003-2006 period adjust to market rates and those who can’t pay lose or sell their homes.
  
  
• The ongoing decline in listings is matched against increased transaction rates. It now is taking more than 60 days to sell a home, twice as long as two years ago. This must compress.
  
  
• Price stabilization occurs when listings reach their lowest levels, a point which we believe is now being approached. But added to this mix will be the sell-off of most foreclosed homes.
  
  
• No fresh inventory creates a shortage of new housing. About 5,900 housing units were permitted in the region through the end of September, suggesting that the actual delivery of new units in 2007 will be at its lowest level in three decades. While bad news for home builders, the low supply increase also will serve to eventually stabilize the market.

Falling Off The Peak

Now, a word on perspective. Year-to-year price drops of 9 percent to 11 percent are sobering but not catastrophic. Smart consumers would use these numbers to inform their housing purchase. We are at a point in the cycle that those with the desire and means to purchase should start thinking about making the move. The best time to buy is at the cycle’s bottom, except you can never tell until later when it was reached. Since home prices have always gone to a new level at the next cycle high, missing the lowest price point near the bottom is not particularly important.

Realistically, the market cycled up for 10 years, three years longer than it might have had it not been for the preponderance of nonconforming loans. Those loans enabled people who should not have qualified for a home (this time around) to prematurely purchase. They were on the edge and they purchased at the market’s peak. This caused the market to fall off a cliff rather than slide down the hill. The only question remaining is if this fall has created such a dust ball that it will capture the rest of the market on its way down. Most analysts think not, but we are still to finish this chapter.

Gary H. London is president of The London Group Realty Advisors Inc., providing real estate consulting and economic analysis. Check him out on the Web at londongroup.com or e-mail him at glondon@sandiegometro.com.