By Alejandro Lazo, Los Angeles Times

Home prices in the nation’s largest cities fell in September, a widely followed index showed, underscoring the unrelenting weakness in the housing market that could last well into next year.

The Standard & Poor’s/Case-Shiller index of 20 American cities, a key measure that is closely watched by economists, declined 0.6% from August to September and 3.6% from September 2010. The drop ended five months of month-over-month gains.

Analysts had expected a decline in prices given the end of the busy home-shopping season. Nevertheless, the reversal of home-price gains casts a cloud over recent data that had shown some improvement in housing, such as increased builder confidence and an uptick in building starts. With the fresh home-price data released Tuesday, several analysts noted that a recovery remains out of sight this year.

“Any chance for a sustained recovery will probably need a stronger economy,” said David M. Blitzer, chairman of the S&P index committee.

Home prices, as measured by the 20-city index, are 2% above their bottom hit in April 2009 during the depths of the financial crisis. Prices briefly dipped below that threshold in March but began gaining ground again as the spring and summer selling seasons pushed prices up.

New foreclosure actions and weak demand probably will drive prices down an additional 5% to 10%, and perhaps more, if the economy slips into a double-dip recession, economists Patrick Newport and Michelle Valverde wrote in a research note Tuesday. The two, who track the U.S. economy for consulting firm IHS Global Insight, said the large number of people who remain behind on their mortgages and the high percentage of American homeowners who owe more on their properties than they are worth will also be a major drag on housing for the foreseeable future.

“Add to this the current high unemployment and underemployment rates, one gets a recipe for further price declines,” the economists wrote. “Should the economy slip into a recession … the unemployment rate will climb, driving foreclosures up and leading to an even larger drop in home prices.”

Even if prices begin to show some strength next year, they will probably continue to muddle along as foreclosures continue to cycle through the market, said Paul Diggle, property economist for Capital Economics.

“Even when prices do reach their trough, which could be next year, a continued influx of foreclosed and vacant properties onto the market will prevent the sharp bounce back that valuations might suggest is due,” he wrote in a note.

In a speech Tuesday at the Federal Reserve Bank of San Francisco, Federal Reserve Vice Chair Janet L. Yellen called for more housing stimulus.

“A sharp downturn in housing was at the core of the previous recession, and this sector continues to weigh on the recovery,” she said. “I see a strong case for additional policies to foster more rapid recovery in the housing sector.”

All of the California cities in the index posted price declines from August. Los Angeles and San Diego were down 0.8%, and San Francisco fell 1.5%.

Despite the declines, home prices in California cities measured by the index are comparatively healthy despite the state’s high unemployment rate. The markets tracked by the index are close to key job centers such as Hollywood and Silicon Valley and are also near the ocean, where overbuilding was relatively restrained.

The index does not track prices in California’s Central Valley or the Inland Empire, where housing is still weak and the foreclosure rates of many cities are among the nation’s highest.

Three U.S. cities posted new crisis lows in September, according to the Case-Shiller index. Both Atlanta and Phoenix joined Las Vegas in plumbing fresh depths. While Phoenix home prices are almost back to their January 2000 levels, those in Atlanta and Las Vegas have fallen below that benchmark.

A separate index by S&P/Case-Shiller measuring national home prices ticked up 0.1% from the second quarter, putting home prices at the same level they were at in the third quarter of 2003. The national index posted a year-over-year decline of 3.9%, which was better than the 5.8% drop in the second quarter.

The news that home prices had renewed their decline came as CoreLogic, a Santa Ana research firm that tracks the mortgage market, reported that more than 1 in 5 American home mortgages were underwater.

An estimated 10.7-million households, or 22.1% of all homes with mortgages, had more debt on the properties than they were worth in the third quarter, according to CoreLogic. This is a slight decline from the 10.9 million properties that were underwater in the second quarter.

“Although slightly down, negative equity remains very high and renders many borrowers vulnerable when negative economic shocks occur, such as job loss or illness,” CoreLogic Chief Economist Mark Fleming said. “The nearly $700-billion mortgage debt overhang has touched many corners of the market, and this overhang is holding back the recovery of the housing market and broader economy.”

Nevada led all states with 58% of mortgaged homes underwater, followed by Arizona, 47%; Florida, 44%; Michigan, 35%; and Georgia, 30%. This was the first quarter that Georgia made the top five, ousting California, which had been among the top spots since CoreLogic began tracking the data in 2009.

By Jack Hough

U.S. house prices have plunged by nearly a third since 2006, and homeownership rates are falling at the fastest pace since the Great Depression.

The good news? Two key measures now suggest it’s an excellent time to buy a house, either to live in for the long term or for investment income (but not for a quick flip). First, the nation’s ratio of house prices to yearly rents is nearly restored to its prebubble average. Second, when mortgage rates are taken into consideration, houses are the most affordable they have been in decades.

Two of the silliest mantras during the real-estate bubble were that a house is the best investment you will ever make and that a renter “throws money down the drain.” Whether buying is a better deal than renting isn’t a stagnant fact but a changing condition that depends on the relationship between prices and rents, the cost of financing and other factors.

But the math is turning in buyers’ favor. Stock-oriented folks can think of a house’s price/rent ratio as akin to a stock’s price/earnings ratio, in that it compares the cost of an asset with the money the asset is capable of generating. For investors, a lower ratio suggests more income for the price. For prospective homeowners, a lower ratio makes owning more attractive than renting, all else equal.

Nationwide, the ratio of home prices to yearly rents is 11.3, down from 18.5 at the peak of the bubble, according to Moody’s Analytics. The average from 1989 to 2003 was about 10, so valuations aren’t quite back to normal.

But for most home buyers, mortgage rates are a key determinant of their total costs. Rates are so low now that houses in many markets look like bargains, even if price/rent ratios aren’t hitting new lows. The 30-year mortgage rate rose to 4.12% this week from a record low of 3.94% last week, Freddie Mac said Thursday. (The rates assume 0.8% in prepaid interest, or “points.”) The latest rate is still less than half the average since 1971.

As a result, house payments are more affordable than they have been in decades. The National Association of Realtors Housing Affordability Index hit 183.7 in August, near its record high in data going back to 1970. The index’s historic average is roughly 120. A reading of 100 would mean that a median-income family with a 20% down payment can afford a mortgage on a median-price home. So today’s buyers can afford handsome houses—but prudent ones might opt for moderate houses with skimpy payments.

For example, the median home in the greater Phoenix market, including houses, condos and co-ops, costs $121,700, according to Zillow.com. With a 20% down payment and a 4.12% mortgage rate, a buyer’s monthly payment would be about $470. Rent for a comparable house would be more than $1,100 a month, according to data provided by Zillow.com.

Of course, all of this assumes mortgages are available—no given now that lending standards have tightened. But long-term data on down payments and credit scores suggest conditions are more normal than many buyers think, according to Stan Humphries, chief economist at Zillow. “If you have good credit, a job and a down payment, you can get a mortgage,” Mr. Humphries says. “There’s more paperwork and scrutiny than five years ago, but things are pretty much like they were in the ’80s and ’90s.”

Not all housing markets are bargains. Mr. Humphries says Zillow has developed a new price/rent ratio that uses estimates for each individual property rather than city medians, to better reflect the choices facing typical buyers. A fresh look at the numbers suggests Detroit and Miami are plenty cheap for buyers, with price/rent ratios of 5.6 and 7.7, respectively. New York and San Francisco are more expensive, with ratios of 17.6 and 17.2, respectively. The median ratio for 169 markets is 10.7.

For investors seeking income, one back-of-the-envelope way of seeing how these numbers stack up against yields for other assets is to divide 1 by the price/rent ratio, resulting in a rent “yield.” The median market’s rent yield is 9.3% and Detroit’s is 17.9%.

Investors would then subtract for taxes, insurance, upkeep and other expenses—costs that vary widely. But suppose total costs were 4% of the purchase price. That would still leave a 5.3% rent yield in the typical market. With the 10-year Treasury yield at 2.2% and the Standard & Poor’s 500-stock index carrying a dividend yield of 2.1%, rents for residential housing in many markets look attractive.

A few caveats are in order. First, not all transactions are average ones. Even in low-priced markets, buyers should shop carefully. Second, prices could fall further. Celia Chen, a senior director at Moody’s Analytics, expects prices to drop 3% before bottoming early next year and rising slowly thereafter. “If the economy slips back into recession, however, we could easily see a 10% drop,” Ms. Chen says.

And property “flipping” can be dangerous even when prices are rising. That is because, absent a real-estate boom, house price gains simply aren’t that exciting. Research by Yale economist Robert Shiller suggests houses more or less track the rate of inflation over long time periods.

Houses aren’t the magic wealth creators they were made out to be during the bubble. But when prices are low, loans are cheap and plump investment yields are scarce, buyers should jump.