When Amy Bohutinsky bought her Greenlake home exactly two years ago, she and her husband chose a small house in which to start their family. "At the time, we said this is a great small-family home, and if we expand our family, we'll need something bigger," recalls Bohutinsky, who gave birth to her first child in November 2007.

Today, Bohutinsky is considering having more children, but her housing plans have changed. "It's no longer a question of trading up but how we can make the current house work for five years," she says. "We do not want to lose money on the home."

The question homeowners in her situation have to ask themselves, she adds, is, "Do I have to sell now?" It's a question with no definitive answer.

Bohutinsky, vice president of communications at the Seattle-based Zillow online real-estate service, is part of an unfortunate sliver of the real estate market: people who purchased a house in the past three years. For many in this segment, their home values are now worth less than what they paid.

The most recent real-estate figures available at press time were not very encouraging. According to Zillow, homeowners in the Seattle-Tacoma-Bellevue metropolitan statistical area (MSA) saw their home prices drop by 9.3 percent, year over year, during the third fiscal quarter of 2008. This decrease has left more than one in five purchasers in 2006, 2007 and 2008 owing more on their house than it is currently worth.Overall, home prices in the King, Pierce and Snohomish county area have dropped 11.2 percent from the real-estate market's peak, which experts say was the second quarter of 2007.

The Northwest Multiple Listing Service also reported that the October 2008 median price of a home in King County dropped to $358,000. It was the first time since early 2006 that the median price had dropped below $400,000. Local real estate experts and economists say housing values will recover some of the pricing power lost in the last half of 2008, but most agree that it won't happen in 2009 due to the national recession and uncertain economic climate.

Historically, national recessions have averaged 10 and a half months in duration; the last two downturns were a bit shorter, lasting eight months. Any other predictions as to the degree or duration of the expected economic recovery, however, are hard to come by these days.

Given the last few months of economic turmoil, many economists say we are heading into uncharted territory. "You don't know what you don't know," says Michael Parks, publisher of Marple's Pacific Northwest Letter, which tracks the local economy. "I haven't seen this movie before, so I don't know how it ends. We live in extraordinary times."

A Matter of Perspective

Before Seattle homeowners start hoarding food and converting assets into gold bars, it's important to establish some healthy perspective about the current real estate market.

For starters, the Seattle area's 11.2 percent drop in house values isn't much when compared to harder-hit cities in California, Florida and Nevada, where home prices in August dropped from 25 percent to more than 30 percent, depending upon the market, according to the Case-Shiller index.

In fact, Bohutinsky says, despite the recent downturn, those owning homes in the Seattle area for at least five years have still enjoyed an annualized appreciation of 6.6 percent. "That's important because it shows that a lot of homeowners still have a substantial amount of value growth in their home," she explains. "The people who are suffering the most are the people who bought in the peak of the market in 2007."

In Seattle, the economy chugged along for two years after the national economy tripped up, thanks to strong local economic engines such as Microsoft Corp., The Boeing Co. and a booming construction industry, says Doug Pedersen, a regional economist and co-founder of The Puget Sound Economic Forecaster newsletter in Seattle. Before last fall, Pedersen says, job creation here had been growing at twice the rate of the U.S. economy, with job figures expanding close to 3 percent, even into the first quarter of 2008.

Low Subprime Exposure

One of the many ironies of the economic crisis is that its most spectacular collapse--the failure of Washington Mutual, due mostly to unscrupulous mortgage lending--occurred in Seattle, one of the regions of the country that was least affected by subprime loans. "We didn't see the speculation other markets had," says J. Lennox Scott, CEO of John L. Scott Real Estate. "We had a healthy market, with real buyers buying homes."

California, Florida and Nevada, on the other hand, were considered "ground zero" in the subprime mortgage crisis because a high percentage of residents in those states engaged in speculative housing purchases, using risky, adjustable-rate mortgages and other new mortgage products to buy homes that were well out of their price range. As a result, those markets experienced a much larger run-up in housing prices and are now suffering eye-popping drops of 50 percent in some cases.

One reason that the Puget Sound region has so far weathered the mortgage meltdown is because it was not considered a "subprime" market. The majority of loans originated here in the Puget Sound area are well qualified, says Geoff Wood, president of Windermere Real Estate in Seattle. In other words, people taking out the loans in the Puget Sound area were, in most cases, required to have a down payment, assets, a good credit history, steady income and other factors.

"Here, you actually needed to have a job if you were going to get a mortgage," explains Matthew Gardner, principal with Gardner Johnson, a land-use economist firm in Seattle. As a result, he adds, "our foreclosure rate isn't like other parts of the country."

Although the combined foreclosure rate for King, Pierce and Snohomish counties jumped 10 percent in the last six months, the area's foreclosure rate stands at about 8.4 percent, according to the most current figures released by Zillow at press time. Realtytrac.com showed that 2,540 foreclosures were filed in the Seattle MSA in October 2008, down sharply from the 4,300 filed during August of that year. That's relatively low compared to other MSAs: in October, Riverside/San Bernardino, Calif., had 43,294 foreclosures, Los Angeles/Long Beach, Calif., had 40,096 and Phoenix/Mesa, Ariz., had 34,217.

Glenn Crellin, director of the Washington Center for Real Estate Research in Pullman, cautions that the Seattle metro area is not quite out of the woods yet in terms of the subprime mess. The region won't get the full picture of its total exposure to toxic loans until later this year. "Because our market was strong much longer than in California and Las Vegas, we still have a significant amount of adjustable loans due to reset in 2009," he adds.

A Hiccup in the Cycle?

In times of uncertainty such as these, real-estate analysts often point to the long-range cyclical nature of the market as a guide. Historically, the Seattle real-estate market goes through a 10-year cycle, says J. Lennox Scott. Typically, this cycle starts with three years of a declining market, then stabilizes for three years, followed by another three or four years of market appreciation. And then the pattern begins anew with another plunge, he adds.

The good news is that a decline, and a new cycle, started back in September 2007. The bad news is that this downward trend should last two more years--but only if the cycle theory holds up under today's extraordinary economic circumstances.

Scott, a veteran of four such boom-and-bust periods, claims that the most recent cycle was cut short to just seven years due to the housing bubble bursting so suddenly in 2007. "In 2005, we had an ultra-frenzied market," he explains. "From 2006 to mid-2007, we had a frenzied market until the credit crunch hit in mid-2007. We operated at a lower adjusted rate until March of [2008], when we saw another 5 percent drop" in sales.

Sales from September 2007 to September 2008 were flat, he says. In October, home sales took a huge dive as activity froze due to the wild gyrations in the stock market and collapses in the investment banking sector. At the same time, while homeowners continued defaulting on their loans in droves, talk began of the $700 billion federal bailout of banks.

It will take a few months, Scott predicts, for the public to regain its footing in the market and for the government to figure out what it plans to do to help homeowners in trouble. "We'll start [2009] off at the lower adjusted plateau and work up to a healthy market in the next several years," he predicts. "Then we'll see an increase in sales activity of 40 percent to 60 percent in the next four to five years."

Restoring Confidence

Nationally, to get back to a good market, banks would have to start lending again and consumer spending would have to increase. Jobs also need to be plentiful, and energy and food prices need to stay reasonable. Restoring consumer confidence will be the catalyst for this turnaround, but it may take longer than some analysts expect.

During the wild month of October 2008, potential buyers froze with fear, says Lisa Milkovich, a realtor with the privately owned John L. Scott office in Renton. She typically sells 30 to 40 houses a year, a mark she expects she will hit for 2008 when the final tally is in. To get to that number in 2009, however, she's ramping up her marketing efforts.

"People are paralyzed and just inundated with the negativity that's happening in the stock market, the economy and the $700 billion bailout," she says. Milkovich had four homes listed from $350,000 to $950,000 in late 2008 and had to slash prices drastically on several listings. But she's had no offers on any of the homes as of mid-November.

And she's far from alone. Real-estate appraiser Alan Pope of Alan L. Pope & Associates said it is unprecedented that for 14 months the Puget Sound area has seen a such a wide gap between the number of available homes and the number of pending sales. In the heydays of 2004 through 2006, the pending activity as a percentage of total homes on the market was about 20 percent. But as the financial credit crunch evaporated the pool of buyers, this gap has widened. At the end of September 2008, some 46,184 houses were for sale in the Northwest Multiple Listing Service. At the same time, only 5,700 houses--just over 12 percent--had sales pending.

To get to a stable market "could take another 18 months," based on historical trends, Pope says. Industry watchers expect housing prices to continue declining until the surplus of homes on the market shrinks to more typical levels. Some predict prices could drop another 10 percent.

Those hardest-hit seem to be owners who have taken out jumbo loans for homes that are priced above $600,000, which represent a large part of the Seattle market, Scott says. Many of these homes are languishing on the market with no buyers in sight.

A Long, Slow Climb

The local outlook for real estate in 2009 will depend entirely upon what's happening in the national economy.

"I'm cautiously pessimistic," says Marple's newsletter publisher Parks."My economic forecast for 2009 is for dramatically slower growth in payroll employment, which implies modest retail sales, more modest income gains, but still growth.

"If the national recession is mild and brief, this region will be able to hold its own, but I think the odds are no better than 50/50," Parks adds.

Regional economist Pedersen had an equally cloudy crystal ball at press time, and was busy revising his outlook based upon the effects of the government bailout plan and the expected new policies by the incoming Obama administration. Before the October meltdown, Pedersen was looking for 1.7 percent growth in 2008, slowing to four tenths of a percent in 2009. Since then, "employment has tended sideways," he says.

Over the next several months, both Parks and Pedersen say they will be watching job growth in four key industries: aerospace, construction, software, and professional and business services. They will also monitor changes in the unemployment rate, new housing permits and home sales."We're still going to see weak job creation," Pedersen adds.

That might be an understatement. Boeing announced recently it will be cutting employment in 2009. It has already announced plans to eliminate 800 jobs at its Wichita, Kan., facilities. But it isn't clear how many positions would be lost in the Puget Sound area.

Hope for Generation Y

Seattle will undoubtedly suffer along with the rest of the country this year from the economic turmoil and looming recession.

But despite all the doom and gloom, the impact on the local real estate market will depend on location. Some neighborhoods closer to the job centers of Seattle and Bellevue have remained relatively strong compared to outlying areas with longer commutes. And no matter what people think, loans are still being made, even some with as little as 3 percent down, Scott says.

Ironically, those looking to buy their first homes are seeing the best real-estate market in a while, Scott says--provided, of course, that they have good down payments and high, steady incomes in this still-high priced market.

"The interest rates are phenomenal," Scott says. "It's a great time to be a first-time buyer. You have great rates, a good selection, no multiple offers and you are buying at the low point of a 10-year cycle."

While baby boomers are moving out of some markets, Scott says watch out--the first waves of "Generation Y," the oldest of whom are now in their mid-20s, are getting ready to buy their first homes. "There are 76 million of them across the nation," he says. "We don't have enough houses for them, so prices are only going to go higher in the first-time buyer category."

Another positive is that Seattle remains a destination area, and the state is still expected gain thousands of new residents each year. "I tell people we still have 94 percent employment," Milkovich adds. "Seattle is still a great place to live."

Scott also remains optimistic amid the current real-estate turbulence. "The core of our economy is still strong," he adds. "I don't think the public knows how really good it is."

Best Time for First-Timers?

Today's real-estate trough makes this a great time to buy, but many new
homeowners will have to settle for a condo first.

Phenomenally low interest rates are making a comeback. More people
are moving to the Puget Sound area, home prices are falling and
selection is expanding. At first glance, these factors sound like they
should help spur a new real-estate boom.

But there's a problem.
Many still can't afford the mortgage payments, even at today's reduced
prices. House values in the Puget Sound area have been out of whack for
a while, and despite falling prices, they aren't going to drop back to
more affordable levels.

According to the most recently available
figures from the Northwest Multiple Listing Service, the median price
for a single-family home or condo in King County was $380,315 in
September 2008. The annual income needed to afford that home, assuming
a 10 percent down payment, is $124,137, according to the Center for
Housing Policy. In King County, the median household income ($63,500)
falls far short of that figure. To afford the median-price home, a
family would have to be very wealthy, or a group of people at the
median income would have to pool their money.

"We're starting
to see the [affordability] gap shrink," says Matthew Gardner, principal
with land-use economic firm Gardner Johnson. "But while prices are
coming down, the fact is that they still are out of reach for a lot of
people."

Glenn Crellin, director of Washington State University's
Washington Center for Real Estate Research, tracks the price of
single-family homes through a metric called the "housing affordability
index." In King County, he says, most people have a housing
affordability index of 74, meaning that they earn only about 74 percent
of the income required to purchase a single-family home. "For
first-time homebuyers," he adds, "the index is 41 percent."

Wages
would have to rise dramatically for this affordability gap to shrink,
and few analysts expect that to happen. "The historical values will
never be re-attained," says Crellin. "I don't think our market will
ever get back to where it was in the early 1990s, when the housing
affordability index, even for first-time buyers, was approaching 100."

Getting
to a more sustainable index number, say 80, will require interest rates
to remain low for a long time. "But more than anything else, it will
require an increase in income levels," Crellin says, noting that, for
the most part, incomes are only rising at the rate of inflation.

The
other side of the equation, home pricing, isn't going to solve the
problem either. Prices here would need to fall 36 percent for houses to
be affordable for the median wage earner, according to a Wall Street
Journal study of the national market. At best, real-estate industry
watchers expect prices to fall between 12 and 20 percent.

For
some Washington residents, these continued high prices may mean that
those who rent will have to do so for much longer than they had hoped,
or that a condominium will be their first home purchase. Those wanting
to trade up to a bigger house may also have to wait until first-time
buyers earn enough to purchase their houses.

The impact of the
affordability index "certainly ripples through the entire marketplace,"
says Crellin. "But we do have an affordable condo marketplace. Even
though the high-end market seems to receive all the attention, we have
a significant affordable market and it does provide the best
opportunity for first-time buyers."