People are wondering how far home prices have to fall before hitting bottom, or some sustainable level. One way is to look at what a price reversion to trend would entail.

From 1982 to 2001, median existing home prices grew at a 4 percent per year trend rate. We select 2001 as a cut-off, because the Fed dropped the funds rate to 1.75 percent and home sales took off in the subsequent years.

Home prices also surged; until they peaked in 2006, home prices grew at an 8 percent per year pace, double the 1982-2001 trend pace. Home prices have started to correct, with a 2 ½ percent drop in 2007 and 7 percent drop so far this year.

Comparing actual home prices with what the 1982-2001 trend projected, we see that prices in 2006 were almost 40 percent above trend. Current prices are still 16 percent above the trend projection.

If prices are to revert to the trend by next year, they still need to fall another 12 percent from current levels. Reversion to the trend by 2010 would require a 10 percent decline from current levels.

Obviously, prices still have a way to go. However, this also means that homes are becoming more affordable. The home affordability index is now at the highest level since early-2004. (Thanks to Mark Perry at the Carpe Diem blogsite for highlighting this).

Falling home prices aren’t pleasant, but they are part of the market’s self-correction process. It’s also worth noting that even if prices revert to the trend growth rate, a home purchased more than five years ago would still have appreciated in value.