Hawai'i's deflating housing market dragged home sales to a decade low last year, and the slump hasn't spared a sector of residential real estate serving an overwhelming need: affordable housing.

A number of factors, including tighter lending restrictions and rising fears about jobs and the economy, have taken a toll on low and moderate-income households seeking the American Dream in one of the nation's costliest places to own a home.

Even with interest rates falling to historic lows and moderately softening median home prices, the low end of the housing market is expected to face continued challenges.

"Everyone's afraid, and that's just unfortunate," said Peter Savio, a local developer who has converted old apartment buildings into affordable condominiums for first-time buyers. "First-time buyers are scared in the best of markets, and now you're in one of the worst markets."

Homeownership, as opposed to renting, improves housing stability for families and strengthens communities. It also can be a major source for building wealth that helps raise living standards.

"Affordable housing" includes homes priced up to roughly $300,000 for households earning up to the median income, assuming a family size of four, a 4.5 percent interest rate and Ho- nolulu's median family income last year of $63,400, according to the U.S. Department of Housing and Urban Development.

HUD's affordable price boundary tops out at about $430,000 for families earning 140 percent of the median income, or $88,760.

On O'ahu, the median price (meaning half sold for more and half for less) of previously owned homes sold last year was $624,000 for single-family homes and $325,000 for condos.

THREE PROJECTS

The nonprofit Hawai'i HomeOwnership Center estimates there are 27,000 renters on O'ahu who could qualify for a mortgage, and another 13,000 who could qualify if they reduced their debt.

Three years ago, a Joint Legislative Housing and Homeless Task Force estimated that by this year the housing demand for those earning up to the median income would be 27,120 additional units statewide and 19,650 on O'ahu.

Nowhere near that amount of housing has been produced since 2006, yet homes priced for that market are sitting unsold.

A few examples of the downturn's impact on entry-level housing include:

• A Waipahu midrise that's only about half sold after more than two years on the market despite prices starting at $131,500.

• A Makiki condo with unit prices starting at $261,000 where the developer stopped marketing units for sale last month and is instead renting them.

• A Kapolei townhome project with prices starting at $320,000 that's trying to attract buyers with incentives that include suspending maintenance fees for a year, no loan closing costs and up to $3,000 in design option credits.

MARKET DYNAMICS

Some observers believe the interest among first-time buyers remains strong, but the determination or ability to buy has been whittled down by market dynamics.

The HomeOwnership Center, which helps people overcome challenges to buying their first home, attracted more prospective clients to orientation presentations in each of the last two years, but enrollment in the program working toward homeownership has declined — to 256 members last year from 307 in the prior year and 363 in the year before that.

Real estate experts say several events in the past year are inhibiting affordable homebuyers, chief among them the implosion of subprime lending that caused mortgage lenders to quit offering loans that did not require a down payment.

Lenders also raised credit scores needed to qualify for a mortgage, further reducing the ability of low to moderate-income earners to buy.

Another major factor is the economic downturn that has put fear of job layoffs in the minds of many residents worried about their future ability to make mortgage payments. Others have lost jobs or work hours that have taken them out of the market for a home.

The general decline in property values that began last year has had a mixed effect. It has sidelined some buyers who believe prices will go down further, and it has made it more challenging to sell state-sponsored affordable projects because the price gap has narrowed between those projects, which have restrictions on resales and income limits, and comparable homes at market prices.

But lower prices also make homes affordable to more people who previously couldn't buy, thus expanding the pool of buyers.

Interest rates that fell to historic lows in recent weeks are also expected to help spark some resurgence in affordable home purchases.

"I think this low interest rate environment is the spark that we need," said Dennis S. Oshiro, executive director of the HomeOwnership Center.

LOWER INTEREST RATES

At last year's peak average interest rate of 6.5 percent, the monthly mortgage payment on principal and interest would be $1,952 on a $325,000 home assuming a 5 percent down payment.

At 4.5 percent, the payment drops by $388 a month to $1,564. The difference roughly equates to $1,200 a month less income required for a buyer to qualify for the loan.

The low interest rates have raised prospects for several affordable housing projects that have been struggling with the market downturn.

One project hit hard by market changes is the Waipahu midrise called Plantation Town Apartments. The fee-simple project with 330 units built on state land initially hit the market in September 2006.

In early 2007, about 170 people had reserved units or signed purchase contracts. Today, six months after construction was completed, only about 180 units are sold, according to Savio, whose brokerage firm, Hawaiian Island Homes, replaced another broker handling Plantation Town sales about 18 months ago.

Plantation Town prices range from $131,500 for 362-square-foot one-bedroom units to $302,000 for 643-square-foot three-bedroom units. Buyers may not earn more than 110 percent of Hono- lulu's median income.

Savio said he believes the demand for units remains high, based on roughly 425 people who submitted paperwork seeking to buy.

"I think the demand is very strong, but the ability to qualify (for a loan) is a problem."

The sales results for Plantation Town led an adjacent 70-unit affordable project called Mokuola Vista, which also was built on state land, to cancel its sale plan a year ago and convert the project to rentals.

CREATIVE INCENTIVES

In Makiki, local development firm Avalon Development Co. bought and renovated the 88-unit Makini rental building and converted the midrise to condos for sale. After an open house in January 2007, people reserved 52 of 88 units that started at $261,000.

Last month, the developer ceased marketing 32 units still unsold and said it will rent them out.

Other developers have been waiting out slow sales, or seeking to boost sales by offering incentives, from below-market interest rates to free Segways.

Nohona at Kapolei was a state-backed affordable housing project with 118 two- and three-bedroom units built on state land by private developer Castle & Cooke Hawai'i. Marketing efforts began in late 2007 for the project to be built in phases for buyers earning up to 140 percent of the median income. Prices range from about $320,000 to $390,000.

Bruce Barrett, Castle & Cooke's executive vice president of residential operations, said 37 units sold in a six-month period of sales activity last year, which was slightly below target. This year, the company is aiming to sell 60 units, and is employing several tactics to attract buyers, including extra marketing and a package of incentives.

Enticements include buying down the interest rate to 4.6 percent, not charging points or closing costs on the loan, covering maintenance fees until Jan. 1, 2010, and offering up to a $3,000 credit for design options.

Also, the company in December obtained approval from the state to eliminate the income limit for buyers on half the units, though buyers meeting the income limit will have priority.

In town, Abe Lee Realty purchased an old 21-unit apartment complex at 2765 Kapi'olani Blvd. near Kaimuki High School two years ago and converted the property into renovated condos for sale at prices from roughly $150,000 to $250,000.

To date, 10 units have sold and three more are in escrow. "We definitely want to sell the remaining eight, but the slowdown in the market and stricter financing requirements have affected us like the rest of the market," said Abe Lee Realty agent Scott Sakata.

A more recent Abe Lee Realty apartment-to-condo conversion project in Makiki has fared better, with 15 of its 20 units sold since sales began in September.

"In this market I thought it might be a little tough, but they're flying out the door," said Adam Lee, a partner in the project. Lee said all but one of the buyers is an owner-occupant.

The project at 1402 Pi'ikoi St. features renovated two-bedroom units with about 650 square feet of interior space plus a lanai, selling for $310,000.

Lee said amenities, including Pergo wood flooring, granite countertops, major appliances, air conditioning and one year free high-speed Internet access, have helped sales. Other incentives: a free Segway and a 32-inch flat-screen TV.

A FIRST-TIME BUYER

Craig Makiya, a civilian airplane maintenance worker for the Department of Defense, bought one of the Pi'ikoi units with his wife, but not after struggling with the decision to become a first-time homeowner.

"I think we made the right decision," he said. "We're still scared. We don't know what's going to happen five years from now. If I can handle (the mortgage) with the economy being this bad, hopefully it'll only get better and life will get easier."

Makiya, 45, said the incentives — a couple of federal tax credits, confidence in his job security and guidance from the development team — overcame doubts he had about buying his first home.

Savio said many renters don't realize that with available tax credits that also include deductions on interest payments, they can own a home for about as much as they pay in rent.

"The economy is bad, but housing is housing," he said. "You need to pay for that in a good economy or a bad economy."