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Kelly Bennett‘s 2007 housing market wrapup quotes local housing analyst Peter Dennehy as saying that “a lot of people believe that this will be the year that the elusive bottom is reached.” Mr. Dennehy is surely correct — many people believe the bottom of the housing market is close at hand. But are they right to do so?

It’s true that prices have taken a protracted hit. According to the Case-Shiller Home Price Index, San Diego prices have in aggregate been falling for about two years now and, as of October, had fallen 13.3 percent from their late-2005 peak.

But this decline, steep as it may seem, must be viewed in the context of the enormous speculative bubble that preceeded it. To the right I’ve included a graph that appeared in a housing bubble overview I wrote last February. (It’s a little too early to update it for 2007 as of yet, and the 2006 version illustrates the point just fine). The graph shows that previous price gains were so huge that a 13.3 percent decline still doesn’t take prices down to anywhere near a level that would be justified by rents or incomes.

Considering the scope of the bubble-era price distortions, 13.3 percent just doesn’t turn out to be all that significant a drop. Factor this in with the slow-moving nature of the real estate market in general (the prior housing bust saw prices decline for six years, and that was after a much smaller boom than we’ve just been through), and it looks like this downturn has a way to go. I don’t know when the price decline will end, but I doubt it will be in 2008.

— RICH TOSCANO

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