For the remainder of 2005, we do not expect a precipitous fall in house prices in Southern California. We generally agree with other economists that the rate of price appreciation is slowing in order to digest the large price gains from the last five years. But the moderating of house price valuations does not equate with prices falling 30 percent or more in the next year, a view of some bubble proponents.


From an economic perspective, housing prices are directly related to the costs of homeownership, movements in demand or supply, interest rate changes and price expectations. Currently, demand far outstrips supply. There is a significant deficit in housing production in Southern California and no evidence of widespread, speculative building.


Available properties for sale in desirable locations remain limited, despite the emergence of infill properties, mixed-use developments and condominium conversions. Also, current homeowners are holding, despite a "sellers" market because they cannot afford higher priced homes in their neighborhoods or don't want to pay more in property taxes. The inventory of homes for sale is expected to remain limited, helping keep prices stable.


Demand for houses in Los Angeles, San Diego, Orange and Ventura Counties will continue to be bolstered in the near term from ongoing moderate job growth and from domestic and foreign buyers attracted to the Southern California lifestyle. Financing has played an important role, as historically low interest rates and new mortgage products continue to fuel the demand for homeownership.


Mortgage financing has become more creative in recent years with many new instruments. This has led to a structural shift in demand with more buyers able to qualify for loans. Even with some tightening of underwriting, the expanded menu of mortgage instruments appears to be a permanent part of the new housing finance environment.


Current home mortgage applications remain at record levels, according to the Mortgage Bankers Association. Further, barring an unforeseen deterioration in the overall economy, risks associated with some of the new adjustable-rate instruments may not be evident for some time, since these mortgages typically offer low fixed rates for three to five years.


Regarding expectations, speculation in Southern California markets has subsided due to the high median price of homes and the relatively low levels of housing affordability. Flipping rates are down from last year. Recent data argue that the market is cooling the rate of price appreciation is slowing to single digit year-over-year gains and the number of transactions is falling towards more sustainable levels of affordability.


Naturally, an unexpected shift to expectations of sizable price drops could cause some homeowners to choose to put their houses on the market. However, the vast majority of homeowners are not speculators but residents. These homeowners well understand the large costs and family disruptions associated with moving and are likely to stay in their homes.


What the debate is really about is whether prices will fall precipitously in the near term. To achieve the large declines that some are predicting typically requires a major economic event that would lead to serious and substantial job losses or a financial shock resulting in large jumps in mortgage rates or a natural disaster that produces a population exodus. In this regard, ongoing job growth in diversified industries should help to keep the regional economy stable.


However, currency and investment decisions by China and other foreign nations could affect the financial markets and need to be monitored. But absent significant movement, the housing market is likely to work itself out in 2005 without a major price drop.


*Raphael Bostic is director of USC's master of real estate development program, Delores Conway is director of USC's Casden Real Estate Economics Forecast and Stuart Gabriel is director of the USC Lusk Center for Real Estate.

For reprint and licensing requests for this article, CLICK HERE.