Good Morning Sonoma County...

This is Fortune Magazine calling...with your wake up call

Welcome to the Dead Zone.

"The stories keep piling up. In many once-sizzling markets around the country, accounts of dropping list prices have replaced tales of waiting lists for unbuilt condos and bidding wars over humdrum three-bedroom colonials."

"The message is clear. Five years of superheated price gains rescued America from stock market collapse, put billions in consumers' pockets, and ignited a building boom that bolstered the nation's economy. (To relive the frenzy, see "Riding the Boom.") But it's over. The great housing bubble has finally started to deflate."

"You won't find that news in broad national statistics or the upbeat comments from the real estate industry. Thelatest official figures, for example, show both new and existing home sales rising in March, a mixed bag on prices - and a record number of new homes on the market."

"But FORTUNE's on-the-ground reporting - in what up to now have been some of the nation's hottest areas - paints a very different picture: Contracts are being canceled, deals are drying up, prices are starting to drop. The psychology is shifting even as thousands of new homes and condos join the for-sale listings each day - so the downward pressure will only get worse."

'"The buyers' sense of urgency is gone," says Bob Toll, CEO of luxury builder Toll Brothers (Research), who has long been a housing bull. "They see the market going soft, so they stall."'

"In California it now takes six months to sell a house, twice as long as a year ago. (See a slideshow of home prices in all the troubled areas.)"

"And what's happening in these areas is a sign of what may be coming in the rest of the bubble zone -- the two dozen or so mainly coastal cities and their suburbs that have seen prices soar in recent years and account for 60 percent of the nation's residential real estate value."

"The problem is as basic as beams and trusses: The triple threat of soaring prices, higher mortgage rates and relentlessly rising property taxes has drastically increased the cost of ownership and put many homes out of reach for a huge number of potential buyers.

In California, for example, only one household in seven can manage the payments on the median-priced house, now selling for $561,000. It takes an income of $134,000 to afford that home."

"There's no mystery about what it will take to close the affordability gap and bring the markets back to life: Prices will have to come down, and incomes will have to move up. Right now the ratio of home values to incomes in the bubble zones is about 40 percent above its historical average. So the only question is how much of the adjustment will come from rising incomes and how much from falling prices."

"With houses hovering beyond the reach of most potential purchasers, formerly frantic markets grow eerily calm. People who rush to list their homes, hoping to grab a fat gain just before prices break, take them off the market."

"Sales shrink as buyers float low-ball offers, and sellers refuse them. Realtors and mortgage brokers find other jobs. The bubble areas turn into Dead Zones."

"For the past few years the housing boom has driven the economy, adding jobs in construction, remodeling, and real estate services. And consumers gorged on the equity in their homes, taking out a total of $2 trillion via loans, refinancings, and sales over the past five years."

"Those powerful stimulants, which added a full point to annual GDP growth, will soon vanish. If corporate spending or some other force doesn't come along to pick up the slack, we could go into a recession that would cut income growth to zero. Then inflated housing prices would have to shoulder the entire, wrenching adjustment, falling 30 percent or more over several years."

“Delinquencies are already rising rapidly. Since early 2005, delinquency rates have jumped almost 14 percent, to 2.5 percent for prime mortgage loans. ‘The banks will be forced to take back a lot of properties and sell them for the amount of the loan,’ says (economist) Mark Zandi. ‘That will add to the already huge supply on the market.’”

“The most troubled sector of the housing market, the one that will fall first and fastest, is the condominium market. Typically cheaper than houses and easier to buy, sell or rent out, condos are catnip for investors"

“Gary Bahadur, who owns a computer networking company in Los Angeles, bought six condos in California over the past few years. Now he’s putting them all up for sale. ‘I’m getting out of California because it’s topped out,’ he says, ‘The prices are so high that investors can no longer buy a condo and rent it to cover the mortgage."

“Yet even as speculators flee, developers keep throwing up condos at a breakneck pace, in part because if they have already bought the land and poured the foundation, they have no choice but to finish the project."

“Builders don’t have the luxury of waiting out a slump; they need to sell for what they can get. At first they hold the line on base prices by offering incentives. Then, as unsold units collect, they move merchandise with huge discounts.”

"The real losers will be those who bought recently at inflated prices and are forced to sell, usually because they're taking a job in another city or can't make the payments when their adjustable mortgage rate jumps. And speculators who bought overpriced condos in hope of a quick killing are going to get hosed."

Rude Awakening? Need more information? Head to Marinite's place for a little morning mythbusting. Be sure to catch the earlier post marking the new road to Serfdom.

See the guys at BubbleTrack for data on the builders...