By James R. Hagerty

From The Wall Street Journal Online

Just when the gloomier pundits were starting to enjoy the housing slump, optimists are piping up to declare it could be almost over.

Former Federal Reserve Chairman Alan Greenspan, whose interest-rate cuts helped create what he once called “froth” in house prices, said in a speech last week that he detected “early signs of stabilization” in the housing market. Some Wall Street economists also are saying the worst may be behind us.

Not so fast, replies Ian Shepherdson, chief U.S. economist at High Frequency Economics Ltd., a Valhalla, N.Y., research firm: “It’s going to get worse before it gets better.”

Discuss

How long will the housing slump last?

Both camps are making valid points. The maximum impact of falling home construction may have hit the U.S. economy in the third quarter, some economists say. But that doesn’t mean the housing market is on the verge of a miracle recovery. Construction is expected to fall further as builders struggle to shed a glut of unsold homes. And many economists expect house and condominium prices to continue falling for at least an additional six months to a year in parts of the nation where speculators went wild.

For now, the consensus among economists is that the housing downturn will remain a drag on the economy but probably won’t sink the U.S. into a recession next year. Even Mr. Shepherdson, among the most bearish, believes the U.S. has a 60% chance of averting a recession in 2007. In any case, the weak housing market will remain painful for speculators who loaded up on credit to buy near the top — and for millions of people working in housing-related industries. Just last week,Countrywide Financial, the U.S.’s largest mortgage lender, announced plans to shed about 2,500 jobs, or 4.5% of the company’s total.

Largely because residential investment dropped at an annual rate of 17%, inflation-adjusted economic growth in the U.S. slowed to a feeble rate of 1.6% in the third quarter, according to an estimate released by the Commerce Department. Without that drop in residential building, economists said, the growth rate would have been about 2.7%.

After the third-quarter carnage, expect “some gradual improvement from here,” says Peter Kretzmer, a senior economist at Bank of America in New York. He expects residential construction to decline at an annual rate of 13% in the current quarter, 5% in next year’s first quarter and 2.2% in the second quarter before starting to grow again. Mr. Shepherdson disagrees, arguing that the drop in construction will accelerate before the market regains balance.

Offsetting the housing damage are several positives. Gasoline prices and mortgage interest rates have fallen in recent months. The stock-market rally has made some people feel richer, even as those who trust only in real estate feel poorer. And job growth, though unspectacular, continues at a “solid” pace, says Scott Anderson, an economist at Wells Fargo in Minneapolis.

With home prices flat to lower in much of the country, Americans already have less ability to tap their home equity to finance spending. But it is unclear how much effect that will have on consumer spending. Some economists believe that rising wages, the stock-market rally and lower energy costs will be enough to keep Americans loading their shopping carts with iPods and flat-screen TVs.

Mr. Greenspan sees hope in the rate of applications for home-purchase mortgages. After falling in the second half of 2005 and earlier this year, they have leveled off in recent weeks.

Some of the optimists’ arguments are dubious. To bolster its position that the housing market is stabilizing, the National Association of Realtors last week trumpeted a 2.4% decline during September in the number of previously occupied homes offered for sale through multiple-listing services. But the Realtors’ news release didn’t mention that listings almost always decline in September, when the back-to-school season means fewer people are moving. Over the past 20 years, listings have declined an average of 3.4% in September, says Ivy Zelman, a Cleveland-based housing analyst for Credit Suisse.

Ms. Zelman, who last year correctly predicted a plunge in home-builder share prices, thinks investors who now are bidding those prices back up are way too early. Sales of new homes are unlikely to start rising again before early 2008, she says. Meanwhile, “land is going down in value daily,” she says.

Joshua Shapiro, chief U.S. economist at research firm MFR in New York, is more upbeat but still thinks home prices will “stagnate” on a nationwide basis for several years, as rises in parts of the country are offset by continued declines elsewhere. After the unusually steep surge in home prices during the first half of this decade, he says, it will take time for incomes to catch up again with housing costs.

Email your comments to rjeditor@dowjones.com.

– October 31, 2006

By Mark Whitehouse

From The Wall Street Journal Online

Bryan Whalen and Ike Spirou have never met. But through the world of modern mortgage finance, their fates are inextricably linked.

Mr. Whalen, who manages a multibillion-dollar mortgage-bond portfolio at Los Angeles-based Metropolitan West Asset Management, stands to gain if Mr. Spirou, a financially stretched homeowner in New York City, reneges on his mortgage loan. That’s because Mr. Spirou’s $360,000 loan was packaged with thousands of others into a bond, and Mr. Whalen has entered a newfangled derivative contract — similar to an insurance policy — that will pay off if enough loans in the bond go bad.

“The sophistication is remarkable right now,” says Mr. Whalen. “You can profit in any scenario.”

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Even as More Loans Go Sour

Mr. Whalen represents a new breed of investor: people who are using financial instruments to bet against the homeowners they consider most likely to suffer in a housing downturn. Many such investors, including Mr. Whalen, don’t expect the current slide in house prices to lead to widespread economic malaise. Rather, they’re betting on trouble for folks like Mr. Spirou — so-called “subprime” borrowers who have become homeowners thanks to the increasing availability of easy credit.

Whatever happens with Mr. Whalen’s wager, there’s a lot more at stake than his fund’s performance or the roof over Mr. Spirou’s head. Subprime lending has put as many as two million families into homes over the past decade, helping push the U.S. homeownership rate up to 69% from 65% — a major shift toward an “ownership society” that politicians of all stripes have touted as one of the nation’s economic successes. As the bets play out, they will show how much of that success is permanent, and how much a temporary phenomenon fueled by overly aggressive lending.

So far, the subprime market has held up relatively well. But it’s beginning to show some cracks — most evident in the nascent derivatives trade, which provides a useful window into investor sentiment. Since August, when house prices logged their first year-on-year decline in more than a decade, the cost of insurance against defaults on bonds backed by subprime loans has risen as much as 16%, suggesting investors are concerned that more homeowners will start to renege.

“You’ve got a lot of borrowers who didn’t have credit before, and a lot of them don’t know how to manage that credit,” says Dan Castro, managing director at GSC Group, a New York asset-management firm that focuses on the mortgage market. “The place where you’re really going to see fallout is in the subprime.”

The advent of the subprime market reflects a sea change in the way banks make home loans. As recently as the mid-1990s, potential homeowners had to get over high hurdles to borrow money. Background checks could take weeks or months. Lenders typically required down payments of at least 20% of a home’s value. People with dented credit, or young folks without adequate credit histories, had few if any options.

Over the past decade, though, a convergence of factors has emboldened banks to lend where they wouldn’t before. For one, the development of the Internet and advances in computing technology have made it much easier and cheaper to process and package new loans. Electronic databases on borrowers have made it easier for banks to assess the risk of lending to people with shakier credit, while new insurance-like derivatives have helped them mitigate that risk. And robust demand from investors — both in the U.S. and abroad — has given banks a big incentive to lend, because they can easily turn around and resell the loans in the form of bonds, reaping a tidy profit.

As a result, both the volume and variety of subprime loans have boomed. Since the beginning of 2002, banks and specialized lenders such as ACC Capital Holdings Corp.’s Ameriquest Mortgage Co.,New Century Financial Corp., andH&R Block Inc.’s Option One Mortgage Corp. have made some $2.2 trillion in loans. That is more than five times the amount in the preceding five-year period, and includes a growing share of “affordability” products such as “piggyback,” “interest-only” and “no-doc” loans. These products, respectively, allow borrowers to avoid a down payment, make extra-low payments in a loan’s early years, and state their income without supporting documentation. Subprime loans’ actual interest rates are typically much higher than those on more traditional “prime” loans.

Big Role

Foreign investors have played a big role in making money available. Analyst Mike Youngblood at investment bank Friedman, Billings, Ramsey & Co. estimates foreigners snapped up about a third of the $2 trillion in subprime-backed bonds issued since the beginning of 2002, often through investment vehicles known as collateralized debt obligations, or CDOs. These divvy up pools of bonds into slices with different levels of risk and return.

Whatever the drivers, the subprime market’s growth has brought significant political benefits by boosting the home-ownership rate — an achievement that the administrations of President Bush and President Clinton have been quick to claim as their own. A recent study by two researchers at the Federal Reserve Bank of Chicago, Jonas Fisher and Saad Quayyum, suggests that subprime lending alone could account for close to half of the four-percentage-point rise in the ownership rate since 1995, almost as much as demographic changes, low interest rates and government programs combined. What’s more, they surmise that the change could be long-lasting, because the technological innovations that enabled subprime lending are here to stay.

“It’s quite remarkable,” says Mr. Quayyum of subprime’s contribution to homeownership. “This could be a permanent boost.”

That means the market for derivatives on subprime debt could be here to stay, too, along with all the other infrastructure that allows investors to parcel and trade the risk of lending to U.S. home buyers. Some believe this will make the economy more resilient to the current housing downturn by keeping the credit lines open. “You have given people better tools to manage the risks, and this gives you hope that the pendulum’s not going to swing as far back as it has in the past,” says Martin Mьhleisen, an economist at the International Monetary Fund who has studied the mortgage market. “But this new financial world has yet to be tested.”

Back in 2002, Mr. Spirou entered the new world of mortgage finance in more ways than one: He launched a career as a self-described “kick-ass mortgage broker,” and he set his sights on a two-story Colonial-style house right next to his parents’ place in Queens, a middle-class borough of New York.

At the age of 23, with only a few years of credit history, he might have had a hard time getting a traditional home loan. But he found an eager lender in Option One, which lent him $266,000 toward the $300,000 purchase price. The loan required an initial monthly payment of $2,200, which after two years would start floating with short-term interest rates. Option One says it has guidelines in place to make sure its borrowers are able to pay.

At the time, Mr. Spirou could easily afford the loan. He had seen his monthly income jump to more than $10,000 in the midst of the housing boom. Still, he says, he lived beyond his means, taking friends out to dinner at Ruth’s Chris Steak House and buying new clothes for the brokers who worked under him. He also took on loans to buy two new cars — a Pontiac Grand Prix for himself and a Pontiac Grand Am for his mother.

“I was young, naive,” he says. “I had to look like a big shot.”

In late 2003, with some $64,000 in auto and credit-card debts, Mr. Spirou again tapped the subprime market. The rising value of his house allowed him to take out a $360,000 loan from Long Beach Mortgage, a unit of Washington Mutual Inc., despite the fact that his growing debts had dinged his credit rating. After paying off the old loan and some $12,000 in credit-card bills, Mr. Spirou says, the new loan left him with about $65,000 in the bank. “I started using the ATM card like it was going out of style,” he says.

A Washington Mutual spokesman declined to comment.

Warning Signals

The ease with which folks such as Mr. Spirou were borrowing against their homes sent warning signals to some investors. The concern: that in their rush to attract customers amid the housing boom, mortgage lenders were lowering their standards. In 2005, for example, the share of interest-only loans grew to about 18% of all subprime loans, from next to nothing in 2001, according to data provider First American Loan Performance. Over the same period, the share of subprime loans that required little or no documentation of the borrower’s income grew to more than 16% from about 10%.

“We looked at this and thought we’re going to see lenders who are misusing these tools,” says Mr. Whalen. “We’re going to see the performance of their bonds deteriorate.”

At about the same time, in early 2005, Wall Street bankers were developing a new kind of derivative contract that would allow investors such as Mr. Whalen to make bets based on their misgivings. Called a credit-default swap, it had previously been applied mainly to corporate and sovereign bonds. Like an insurance contract, it pays off if a subprime-backed bond suffers a certain amount of losses to defaults. The holder, known as a protection buyer, makes regular payments to a bank or other counterparty for the insurance, and also has the right to resell the contract. If defaults prove higher than expected and the bond starts to look riskier, the value of the contract rises, and the holder can resell it at a profit.

In January 2005, for example, Mr. Whalen bought an insurance contract on the Long Beach Mortgage Loan Trust 2004-2, the bond into which Mr. Spirou’s loan had been packaged. He agreed to pay the counterparty, Citigroup Inc., $20,300 a year for a contract that would pay up to $1 million if more than 3.35% of the loans originally in the bond went bad. So far, the wager hasn’t made money: He says he could sell the insurance for close to what he paid.

Mr. Whalen sees the new derivatives mainly as a hedge against the riskiest part of the subprime market. He looks to bet against bonds with high concentrations of loans to people who have low credit scores, who did “no-doc” loans, or whose homes aren’t worth much more than they owe on their mortgages.

“These are the marginal guys,” he says. “It doesn’t mean the mortgage market is a bad market to invest in. It means you have to make sure you stay away from certain borrowers.” For the most part, Mr. Whalen is still bullish: His fund owns some $300 million in subprime-backed bonds, mostly higher-rated issues.

Lately, though, more investors have started worrying about what will happen to subprime borrowers as house prices plateau and start to fall. Rising home values rescued many borrowers who didn’t have enough income to make their payments, because they were able to take the needed cash out of their homes. Now, if homeowners run into income problems and can’t sell their houses for enough to pay off their loans, they will be left with no option but to let the bank take the house.

“While prices are appreciating or steady, people try harder to make those mortgage payments,” says Stuart Feldstein, president of SMR Research Corp. in Hackettstown, N.J., which has done studies of house prices and foreclosures during previous downturns in California, Texas and other states. “But when their investments become worth less than what they owe, they tend to just walk away.”

What’s more, many will face an added shock as the monthly payments on their loans — most of which are fixed for only two years — reset to reflect higher interest rates. Christopher Cagan, director of research at First American Real Estate Solutions in Santa Ana, Calif., estimates that about $640 billion in subprime loans made in 2004 and 2005 will reset to higher rates over the next five years — a trend that he expects will lead to some 450,000 added defaults.

“And that’s just resets,” he says. “That’s not including things like job loss, divorce, death in the family or serious illness.”

Falling Standards

Meanwhile, data on loan delinquencies suggest that lending standards have indeed fallen. As of August, about 3% of borrowers who took out subprime loans in 2006 were more than 60 days behind on their payments — about three times the level two years earlier and more than four times the level for all types of borrowers. Kenneth Rosen, chairman of the Fisher Center for Real Estate and Urban Economics at the University of California, Berkeley, predicts that by 2008 as many as one in five of all subprime borrowers will be in arrears, and that foreclosures will help send the homeownership rate back down by about a percentage point.

“While 80% of this is a good thing, the 20% that’s bad is going to come home to haunt us,” he says. “That’s just the way it happens: Bad practices get exposed in the downturns.”

That worry is reflected in the derivatives market. The annual cost of $1 million in insurance against moderately risky subprime-backed bonds has gone from a low of about $21,500 in early August to $25,000 Friday, and has spiked as high as $27,800. Market participants say big hedge funds increasingly are using the derivatives to make outright bets against U.S. homeowners. This summer, for example, New York hedge-fund manager Paulson & Co. launched a fund that has aimed specifically at profiting on subprime defaults.

“People are more nervous,” says Greg Miller, a portfolio manager at Saye Capital, a Los Angeles-based hedge fund active in the subprime market. “It could get ugly. If there is a significant pickup in defaults there are going to be a lot of bad bonds out there, and CDOs could be in trouble.”

Mr. Spirou’s situation offers a glimpse into the difficulties many homeowners face. As the housing boom has faded, his income from the mortgage brokerage business has fallen to about $6,000 a month. As a result, he’s gone into arrears on his own mortgage. To catch up, he must now make payments of about $3,200 a month, up from $2,600 when he took out the loan. His other payments on credit cards and auto loans add up to about $2,500. Meanwhile, he says, the interest rate on his loan is scheduled to reset in December.

“It’s going to be a fight,” he says. “I’m just waiting to see how these next couple months of business are going to be — if I can get myself back on my feet.” He says he’s been considering selling his house, but so far hasn’t found a buyer willing to pay the right price. He’s also looking into ways to get another loan.

Email your comments to rjeditor@dowjones.com.

– October 31, 2006

By June Fletcher

Question: We put our house on the market late in June. Since then, we have had lots of people come through but no bites. We have been told that our house will be a teardown and that it probably will be sold to a contractor or builder. Since we’re coming to the holiday season and winter months, should we take it off the market for November through the end of January and get the kick of a new listing in February?

–Tom Sommer, Inverness, Ill.

Tom: For everything there is a time and a season — and late fall isn’t the season to be selling a home.

House Talk

More Q&A columns by June Fletcher.

When thoughts turn to turkey, mistletoe and cozy evenings by the fire, the last thing people want to do is get out boxes and start throwing things in them — except, of course, when they’re wrapping last-minute holiday gifts. Moving seems like too much of a hassle during the holidays. If ever there was a time to take your house off the market and let your listing “refresh,” this is it.

Why should this matter when think you’re going to sell to a builder? Because you probably won’t — at least not directly. Unless your house sits on a large, subdividable parcel of land, you will likely sell to a buyer who’ll hire a contractor later.

With the housing market cooling very rapidly, finding a builder who’s willing to take on a speculative project is going to become more and more difficult. The rate of single-family starts fell 41.2% to 1.53 million this month, and permits have nose-dived, according to the National Association of Home Builders.New single-family home sales hit an annual rate of 1.075 million in September, down 14.2% from the same month a year before, according to government statistics. Until the housing market recovers from its current slump — which some housing economists don’t think will happen until 2009 — even small builders will be fixated on getting rid of their existing backlog of properties, not starting new ventures.

Which is why I wouldn’t spend the holidays baking sugar cookies if I were you. Use the time while your house is off the market to create a more aggressive marketing plan, one that throws your net as wide as possible. Yes, you or your real estate agent should be contacting local builders who have customers in the pipeline and just need a lot, but you should also be canvassing remodelers, antique-store owners, neighbors and others who might know someone who’d like a smaller, older home. After all, you can’t be sure your house will be torn down — new owners might decide to renovate it instead.

With that in mind, spend some time cleaning and decluttering your home and keeping the landscape trimmed, even if you don’t want to spend the money and effort to replace outdated items that buyers care about, like flooring, countertops, roofing and appliances. If the new owners only care about the land and don’t plan to keep the house, they’ll likely pay more for a property that you obviously have loved.

– June Fletcher is a staff reporter at The Wall Street Journal and the author of “House Poor” (Harper Collins, 2005). Her “House Talk” column appears most Mondays on RealEstateJournal.com. Email your questions about the residential real-estate market. Please include your name, city and state. If you don’t want your name used in our column, please indicate that. Due to volume of mail received, we regret that we cannot answer every question.

Join a reader discussion about the residential real-estate market.

Email your comments to june.fletcher@wsj.com.

– October 30, 2006

By Will Geiger

From The Wall Street Journal Online

Closet space is coveted in homes, but most people still can’t make order out of the chaos that lurks behind closed doors.

Not that serious money isn’t spent trying. Americans drop more than $1.2 billion a year to spruce up closets, more than 20% of what they spend on home organization overall, according to Fredonia Group, a market researcher.

We decided to find out just how tough — and expensive — it can be to rearrange closet space. The issue with our tester’s jam-packed closet: It is 18 inches deep (around 24″ is standard), so oversize sliding doors rub against bulky items like suits. A lone shelf along the top provides cramped storage. One upside is that it stretches nearly 10 feet across. In our hallway we have a combined utility closet and spare pantry. It is barely 13 inches deep, with shelves that stop two inches short of the front wall. While the closet interior reaches to a nine-foot ceiling, the doors are standard height, blocking access to the top few feet. That leaves far more room in this cupboard than we can utilize.

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We approached five organizational experts to see if they could offer an answer. We found that not everyone could find a solution for both spaces, but we were happy overall with the range of ideas. The best came from a local carpenter, who suggested a low-cost way to make use of the high areas of our closet. In the bedroom, the best ideas were to replace the doors to get more depth and to go to the Container Store for new shelves and rods.

The California Closets consultant took about 90 minutes to measure the closets and formulate ideas. We liked putting in our two cents on how many shelves we wanted for shoes and how much hanging space we needed. In the hallway, he offered to increase the number of shelves to increase the usable space. But given all the tall items we keep there, like a stockpot and extra vases, we suspect we’d wind up removing a few after the system was installed. And he wasn’t able to improve access to the top of the closet.

Dealing with the Container Store was frustrating. We had to take numerous measurements and plug them in to a form on the store’s Web site along with details about how we use the closets. Then we could go to the store or ask for a phone consultation. We opted for the latter. A consultant said the store’s shelves wouldn’t fit our hallway at all — disappointing! — but a separate discussion about the bedroom seemed to go well. She said she could work with our odd dimensions. The resulting plans showed plenty of room for suits, pants, shirts, shoes and folded clothes, but no place to hang long items like dresses or coats. We swapped emails but the online consultants couldn’t create a plan that worked for us.

We found a professional organizer through a referral Web site (www.onlineorganizing.com). Her ideas for the bedroom ran from simple (such as replacing the closet doors with drapes to save our clothes and soften the room) to pricey (moving the closet wall out about six inches, which would necessitate shifting the bedroom door and a light switch as well). In the hallway, she suggested cutting a new door frame to bring the doors up to the ceiling, and put us in touch with a local contractor. The contractor advised us that moving the closet wall in the bedroom wouldn’t be worth the cost and hassle. He could recut the doorway in the hall and rebuild the inside to improve the shelving, but it would cost $2,700, by far the highest estimate.

We located a design student by calling a local college. For the bedroom, she suggested bifolding doors that open to the middle (to avoid interfering with items at either end). Then she did some legwork. She sat down with a designer at the Container Store and cooked up a better design for the bedroom than we did by going to the store ourselves. They removed the hanging bar that ran the width of the closet, and added two rows of bars at either end that hung perpendicular to the front wall. Then they filled in the middle with shelves for shoes and folded clothes, and with hanging space for dresses. It would cost about $500, or a little more if we also got new doors. She also found a shelving system at Ikea that would fit in the hallway closet and be easy to install ourselves. The cost: $200 to $300.

A carpenter, whose work was recommended on a neighborhood Web site, provided solutions that were creative and economical. For the bedroom, he suggested extending the door frame by four inches to make the broad middle of the closet deeper, and upgrading the dark-wood sliding doors. He didn’t have ideas for the inside. For the hallway, he suggested running shelves the full width of the closet along the bottom third to make the most use of that space. He proposed ready-made shelves from a home-improvement store and offered to help buy the right sizes and to install them in case we need to trim the shelves to fit them properly in the tight space.

CONSULTANT COST OF ESTIMATE HOW IT WENT SOLUTION/ESTIMATE FOR WORK COMMENTS California Closets

outlet Free visit Having the designer come to our house was nice, but he said the company doesn’t offer computer mock-ups of closets. New shelves and rods to make different use of the space in both closets; $1,000 for bedroom, $650 for hallway. Not very creative ideas but a reasonable middle ground between expensive custom work and do-it-yourself systems. The Container Store

outlet Free, using phone and email Employees were willing to go back and forth with us several times, but couldn’t find a way for us to hang “long” clothing. No suggestions that really worked; no work estimates. The store’s system didn’t adapt well to our nonstandard closets. Professional organizer found through referral Web site $160 for a visit The organizer offered several solutions from inexpensive quick fixes to extensive construction, but her contractor’s estimate busted our budget. Move the bedroom closet wall out; replace hallway doors to make opening taller; $2,700 for hall closet. We liked that the organizer thought about the house holistically. But having to pay one person for ideas and a second for work can add up. Interior design student found by calling local college $80 for a visit, including sketches She had ideas for improving the inside and faзade, and we liked that she went to several stores to scout ideas for us. New doors in the bedroom and shelving to make different use of the space in both closets; up to $600 for bedroom; up to $300 for hallway. Student got a better bedroom solution from the Container Store than we did, and found shelves at Ikea that would work in the hallway. Local carpenter found through neighborhood Web site Free visit Offered creative and practical solutions while keeping an eye on the bottom line. Extend doorframe in bedroom; add reachable shelving in closet; up to $400 for bedroom; up to $350 for hallway. We could carry out some of his ideas, but would likely have to alter standard shelves or have carpenter do some custom work.

Email your comments to rjeditor@dowjones.com.

– October 30, 2006

Q: I signed a contract a little more than two years ago to purchase a to-be-built condominium unit. I gave the developer a hefty down payment. My sales contract says that settlement must take place within two years. I inspect the building weekly, and it does not look like a lot of work has been done.

I asked the developer when I will go to closing, and his response was that because of matters out of his control, he will not be able to meet the settlement deadline in the sales contract.

Watch out: Home real estate is back in the sights of Capitol Hill tax writers.

The staff of the nonpartisan Joint Committee on Taxation has proposed new options for closing the “tax gap,” which is the difference between federal taxes that should be paid under current tax rules and the amounts collected by the IRS. Recommendations from the committee staff carry substantial weight with members of the Senate and House, and frequently are included in tax legislation.

This has been a big week for George Washington’s Mount Vernon Estate & Gardens, the official name of that extraordinary property overlooking the Potomac River.

The newly built Ford Orientation Center and Donald W. Reynolds Museum and Education Center, treated to front page coverage in Tuesday’s Washington Post, opened to the public yesterday.

Q: DEAR BOB: My house has been on the market for more than 18 months. Despite scores of open houses and showings by agents, no offers. It is a gorgeous five-bedroom, four-bath home with a three-car heated garage. The area is not economically depressed. We can’t figure out any ideas to sell it, without a dramatic drop in price.

– Bryan C.

By Rex Nutting

From Marketwatch

U.S. homebuilders slashed prices at the fastest pace in 36 years in September, boosting sales to the highest level in three months, the government said Thursday.

The government reported that sales of new homes unexpectedly rose 5.3% in September to a seasonally adjusted annual rate of 1.075 million, the most in three months and well above the 1.05 million expected by economists surveyed by MarketWatch.

Related Link

Join a reader discussion on the U.S. housing market.

However, sales in June, July and August were revised down by total of 67,000 annualized, continuing a pattern of downward revisions to the originally reported data.

August’s sales pace was revised to 1.021 million annualized from the 1.050 million initially reported, a 3.8% rise from July’s downwardly revised 984,000 annual pace. Read the full government report.

New-home sales are down 14.2% in the past year and are down 16.5% year-to-date.

“September’s results show the market works — if builders cut prices enough, people will buy,” said Bart Malek, an economist for BMO Nesbitt Burns.

Inventories, prices falling

Inventories of unsold homes fell 1.9% to 557,000, representing a 6.4-month supply at the September sales pace. It’s the second consecutive decline in inventories. The supply of inventory peaked at 7.2 months in July.

Inventories of unsold homes are up 14.4% in the past year. The number of unsold completed homes rose to a record 157,000 in September, up 47% in the past year.

Median sales prices dropped 9.7% in the past year to $217,100, the lowest price in two years. It’s the largest percentage decline in median prices since December 1970. Median prices for existing single-family homes are down 2.5% in the past year, the largest decline ever recorded.

Home builders have piled on incentives, including vacations and new cars, to sell homes. Such incentives are not subtracted from the sales price reported to the government.

“The median price series in both the new and existing home sales reports are not good indicators of short run price swings because they are impacted by shifts in the mix of homes sold,” said David Greenlaw, an economist for Morgan Stanley. In September, there was a 16% dropoff in the number of houses sold for more than $200,000, and a corresponding increase in sales of homes priced under $200,000.

Some economists said the report showed the market is stabilizing, while others said it’ll take months before the bottom is reached.

“This trend, if maintained, points to gradual stabilization in new residential

construction,” said Peter Kretzmer, an economist for Bank of America.

“The pressure on the housing market will not end any time soon amid sky-high inventories and a deteriorating price environment,” said Malek. “Both new and existing single-family home prices are deflating, which will make many households feel poorer, restrain mortgage equity withdrawal, dampen consumer spending and reduce housing starts.”

Quirks in data

Sales are reported when a contract is signed, not at the closing of the sale. Home builders have reported a large increase in cancellations in recent months.

The government cautions that its housing data are subject to large sampling and other statistical errors. Large revisions are common.

The standard error is so high, in fact, that the government cannot be sure sales increased at all in September. The 5.3% increase is statistically meaningless compared with the 15.6% confidence interval.

It can take up to six months for a trend in sales to emerge. New-home sales have averaged 1.10 million per month over the past six months, roughly unchanged over the past four months. The six-month sales average is now down 15% from December.

Regionally, sales rose 24% in the West and rose 6.9% in the South. Sales fell 35% in the Northeast and dropped 6.3% in the Midwest. Except for the drop in the Northeast, none of the changes are statistically meaningful.

In a separate report, the Commerce Department said orders for durable goods soared 7.8% in September on a near-tripling in aircraft orders.

Email your comments to rjeditor@dowjones.com.

– October 27, 2006

By Jane Hodges

The investor: Patrick Watson, 42, became an investor in 2002, shortly after marrying. Mr. Watson, who works in the financial-services industry in Austin, Texas, bought a home in 1995 in the city’s Westlake neighborhood. But after he got married, he and his wife decided it would make sense for them to live in another area of town. In early 2002, Mr. Watson didn’t find any takers after having the property up for sale for three months, due to the effects of the tech bubble’s pop. Mr. Watson then listed it as a rental and swiftly found tenants.

The property: The 1,822-square-foot, single-story home was built in 1978 and has three bedrooms, two baths, a great room with stone fireplace, a separate dining room, a private patio and a two-car garage. The house is close to downtown in a desirable public school system and is on a 7,206-square-foot lot (.17 acre).

Purchase price: $141,000 in July 1995.

Additional investment: $10,000. Mr. Watson says he mainly maintained the property without making major improvements. Over the years he added new gutters, new kitchen appliances, a new air-conditioning compressor and a new furnace.

The strategy: He hadn’t planned on becoming a landlord because he didn’t have the time required, Mr. Watson says. With the monthly $1,625 he collected in rent, he was only able to break even, just covering the property’s expenses, he says. Yet, he decided against keeping the home and raising the rent because he remains too busy to oversee the property, he says. Instead, he’s been waiting for the market to improve from a slump four years ago and feels that the time has come to sell, he says. He’s worked hard to price the house competitively, he says, researching similar rental properties and allowing a roughly $15,000 discount so buyers can afford to make their own cosmetic changes (instead of marking up the home to cover the cost of his fixes).

The pitfalls: He was happy with the property as a primary home and although he couldn’t sell it in 2002, was lucky to have located renters who were handy around the house and punctual with rent, he says. He advises other “accidental investors” like himself to choose tenants carefully, perhaps working with a real estate agent who can run credit and other background checks on potential renters.

The investment property in Austin, Texas

The payoff: $117,130 to $125,800, or at least 83% of the purchase price, depending on whether the buyer uses a real estate agent and assuming the asking price is met. The math works this way: The asking price ($289,000) minus the purchase price ($141,000) comes to $148,000. Mr. Watson said that his cash flow (profit after paying the mortgage, interest, insurance and taxes) was break-even during the four years he rented the property. He expects to pay a 15% capital gains tax, which reduces his figure by $22,200 to $125,800. Although he listed the property as for sale by owner, if a buyer makes an offer via an agent, he is willing to pay a 3% commission, he says, which could further reduce his profit by $8,670, to $117,130. His home is slightly lower in price than it could be, he acknowledges, because he chose not to renovate it prior to selling. He prefers to sell the property at a discount, he says, and let new buyers spend money as they see fit on renovations rather than oversee the renovation process himself. Still, his property tracked area appreciation over time, given he intends to sell it for about $148,000 more than he paid for it, and homes in his zip code have risen in average price by about $160,000 over the past 10 years, according to Zillow.com.

Average rate of return: 7.3% to 7.9%, depending on his final profit. This rate is calculated by dividing Mr. Watson’s profit ($117,130 to $125,800) by his purchase price ($141,000), and dividing that figure by the number of years (11.25) he held the property.

– Ms. Hodges is a free-lance writer in Seattle.

Email your comments to rjeditor@dowjones.com.

– October 27, 2006