Bank of America Merrill Lynch analysts have updated their home price model and think that home prices are currently bottoming out.

However, they still believe the recovery will not earnestly start until 2014.

When they published their proprietary home price model in November, BofA Merrill analysts projected that home prices would drop an added 8% from 2Q11 through 1Q13.

Since the model's release, the 3Q11 and 4Q11 data releases showed that actual home prices dropped 3.2% in 2H11, which means an added 4%-5% dip remained based on their previous projections.

They have more data now since they had made their initial projection. The fresh information includes favorable developments on the policy front, better economic data and a drop in the market's home supply. 

Analysts anticipate mostly flat home prices this year and next with modest growth in 2014.

The main difference from their previous forecast is that prices reach the bottom earlier. However, together with the earlier bottom is a slower recovery, and thus a flatter profile, they said in the report.

They still think prices should be accelerating in later years once most of the foreclosure inventory is absorbed by the market. This allows prices to be in line with income.

From 2012 through 2020, analysts expect a cumulative price growth of 42%, which is similar to their previous prediction.

They said that the two most important short-term variables for their model are months' supply, which is the ratio of inventory to sales, and the distressed sales share.

Both of these are impacted by the flow of foreclosures into the market, which has slowed because of policy intervention. Months supply has tumbled lower recently, reaching 6.4 months in February, dippkng from 9.3 months last July.

Additionaly, the share of distressed sales has been modestly lower than expected, they said, averaging 27% in 4Q11. Analysts projected moderate increases in these parameters in the next two years, although because of ongoing foreclosure prevention efforts, they believe the levels will be less than they had previously anticipated.

They believe there is no silver bullet for regulators to fix the U.S. housing sector. The government's policy moves have been geared at preventing foreclosures, which has delayed the process.

BofA Merrill analysts' price forecast of a long and protracted bottom in home prices is evidence of this policy environment.

They believe that there will be more government programs to prevent foreclosures such as the Home Affordable Modification Program modifications and some limited debt forgiveness defined in the Attorneys General settlement.

Additionally, a pilot program to sell 2,500 FNMA real-estate-owned assets marks the start of another series of policy moves to reduce foreclosures, BofA Merrill analysts noted.

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