Previously Published March 17, 2011, in the California Economic Forecast

A couple of weeks ago, somebody–I think it was Shiller–said that they expected residential real estate price to decline by another 20 percent or more. Soon after, I was contacted and asked if I thought that a 20 percent decline was possible. My answer was that the only thing that would surprise me about residential real estate prices was if they went up 20 percent.

So far at least, residential real estate prices have been doing just about what I’ve expected. They’ve stabilized. Prices and sales move around, but no upward or downward trend is visible in the data. That doesn’t keep the rose-colored-glasses crowd from forecasting an imminent upturn. I don’t think a week goes by where I don’t see that type of piece.

Unfortunately, there is no fundamental reason for an increase in home prices, and plenty of reasons why they may yet decline some more: Unemployment is still high. Underemployment is still high. Long-term unemployment is still high. Residential mortgage delinquency rates are still high. Foreclosure rates are still high. The proportion of people who own the home they live in is still too high. Gasoline prices are rising. Food prices are rising.

What do the bulls have to fall back on? Interest rates are low, and we’ve stopped losing jobs. That is just not enough to hang an ebullient real estate recovery on, especially if you realistically confront the negatives.

Don’t expect residential prices to make big positive moves in 2011 or 2012.

The story for commercial real estate is pretty much the same. Although commercial real estate’s decline lagged that of residential real estate markets, commercial real estate suffered similarly big declines in value, while vacancy rates soared. Lease rates, naturally, reflected the changes and fell also.

However, commercial markets are different from residential markets. On the positive side, commercial real estate markets are only about a third the size of residential real estate markets, implying a much smaller economic impact. On the negative side, commercial real estate financing is much more idiosyncratic than residential real estate financing, and it often involves big balloon payments. The big balloon payments imply that lots of properties could be in trouble. The idiosyncratic financing means that new loans will likely be very hard to find for quite some time. It may also mean that existing lenders may be more flexible before attempting to foreclose.

In sum, the long nightmare that has so tormented real estate market participants is probably not over. Anyone buying in this market needs a very long investment horizon.