Are everyone's favorite neighborhoods suddenly vulnerable?
Buying opportunities in the midrange may equal those of the tech bust, or not. Time will tell.
As anyone who comes to this site frequently knows, the local neighborhoods hit hardest by the fallout from the lending crisis have been the neighborhoods at the lowest end of the price range. In Silicon Valley, the "low end" is any neighborhood where single-family homes currently list at about $500,000 or less.
But as regular readers also know, once you climb above $500k, "distress sales"—foreclosures, short sales and other unduly motivated sellers—progressively thin, and once you reach $900k these sellers have been virtually non-existent. Why is $900k the magic number? Because $900k is the starting point for Silicon Valley's midrange single-family homes, and during the boom these homes had their own set of typical buyers with their own set of typical mortgage products. Moving up the price range, buyers had progressively deeper pockets, and the loan products available to them were less risky because the bigger numbers encouraged more stringent underwriting.
The flood of motivated sellers inundating the low end since late 2007 has meant that low-end home prices have declined sharply, by as much as 45 percent. But until recently the local midrange market was relatively robust and, in some cases, more than relatively robust. Spring 2008 in the midrange market was much like any spring since 2004, with motivated well-qualified buyers competing aggressively for homes in brand-name neighborhoods, particularly for the best homes under $2M.
But starting in September 2008, the stock market began its convincing re-enactment of the catastrophic stock markets of 1931 or 1937, depending on which index you prefer, and local midrange real estate tagged along, as it always does. The low end continues to sell fairly well, although against a backdrop of steadily-declining prices, and what's selling is almost exclusively distressed homes, so much so that they've forced conventional sellers out of many low-end markets. But midrange sales, the neighborhoods most buyers earning great but not Bill Gates-level incomes have focused on over the years, abruptly shut down late last year.
The reasons for this shut-down aren't mysterious, and I use the word "mysterious" deliberately, because so many of those following and reporting on real estate these days seem to ascribe almost voodoo-like powers to the forces behind the market's movements. (Maybe we should go back to calling recessions "panics".)
First, many of Silicon Valley's midrange buyers depend on stock market wealth for their down payment, and late last year that wealth shrank by 40 to 50 percent. Not only did this reduce the size of their down payment, it put them firmly in hunker-down mode. Second and not unrelated, big-time uncertainty finally hit midrange real estate. With the economy suddenly topic A, very few midrange buyers were comfortable assuming the long-term commitment of a mortgage. And third, homes in places like Fremont and San Jose that needed to sell for sellers to be buyers in places like Palo Alto and Mountain View stopped selling, at least at prices high enough to make selling and buying worthwhile.
And, of course, the background noise behind any market—the rumor and innuendo—moved to the foreground to take the starring role. Although most of the millions of casual bystanders to, and even active participants in, the housing market know little more about it than the shock-and-awe headlines they've been hit with since August 2007, they shared the firmly-held belief that all real estate everywhere was in malaise. Which made the multiple offers and high overbids on Palo Alto homes in spring 2008 seem even more unreal. Since September 2008 that belief has matured into a sharp sense that a) everyone's favorite neighborhoods are living on borrowed time, and b) the note is now due.
And indeed, the first small cracks in the local midrange market are starting to appear. A bank-owned home in Palo Alto, for example, not surprisingly a hammered small house, near 101 and in a traditionally affordable neighborhood, but for all that a bank-owned home with all the trimmings that come with bank-owned homes. No longer will Palo Alto agents have to venture to East Palo Alto or central San Jose to get the full bank-owned treatment. Moving south, to Mountain View west of El Camino, one of the mid-Peninsula's more sought-after midrange neighborhoods, we find not one but three short sales, all three, not surprisingly, priced at entry-level, but short sales nonetheless.
But by far the most conspicuous symptom of the midrange slowdown has been a conspicuous lack of midrange sales. Yes, sales have been below par for several years, but for most of that time the cause has been lack of supply, not lack of demand. The real estate market can't sell what doesn't exist, although we have our best minds working on it. But these days the supply of midrange homes is rising, due not to a flood of distressed sellers, but because sales of the homes of non-distressed sellers have slowed to a crawl:
I put far less emphasis on the number of sales than the media does, because I know that inventory tightens during a boom, but it's hard to look at this chart and not think that something's up. Compare Q4 2008's midrange sales with, for example, sales in Q1 2001, when Silicon Valley also had its share of worries about the economy and stock market, and see that sales were 50 percent higher then than they were in late 2008. That's mighty sobering. You never want to be anywhere near 2001 benchmarks, let alone trail them. (By the way, Q1 2009 sales are, obviously, projected.)
And because the midrange market moves in slow motion these days, the average number of days needed to sell a home, called "days on market" or "DOM", has soared upward. The chart below shows how dramatic the increase in DOM has been, compared not only to the market immediately preceding but to other markets this decade.
However, you'll note that midrange average sales price has held up fairly well in the face of plummeting demand and rising supply. The numbers tell us that prices have declined 10 and 15 percent since their early 2008 peak, a significant chunk of change, of course, especially when the average has been well over $1M for several years, but a strong performance compared to the low end.
But what the numbers don't and can't tell is what any midrange home is worth right now. In 2009 sales have been so few and far between that the candid agent will admit that he or she doesn't know how much midrange house X is worth today. He can tell Seller how he'll position midrange house X to get the best possible price in today's market. And he can tell Buyer how to write an offer likely to get midrange house X for the lowest possible price in today's market. But no one knows for sure where prices are today.
The more astute among you may have noticed that in both 2001 and 2008 the relationship between the declining price line and rising DOM line was remarkably similar: in each year, average sales price went down 1 percent for each 4 percent increase in DOM. (I won't comment on 2005, another year in which average price went down and days on market went up, except to say that when DOM rises from a smokin' 13 to a merely sizzling 23, you probably shouldn't make too many inferences from the results.) If the 1-to-4 ratio has some validity, it suggests that Q1 2009's 81 percent increase in DOM should result in prices 20 percent lower than those of Q4 2008. However, I think this reads too much into a short-term market movement, although if days on market stays around 65 all year, prices may well soften more.
You'll notice that I've given Q1 2009 an average sales price anyway, despite the uncertainty. About the only thing I'm certain of is that, when so few homes are selling, the prices of most homes on the market are significantly too high. By "significantly too high" I mean that the average person trying to sell the average midrange home has missed the market-correct list price by more than a few bucks. The depressed level of sales suggests that the homes lingering on the market unsold these days are at least 5 percent over-priced. Plug Q4 2008 average sales price minus 5 percent into the Q1 2009 price slot and you come up with a market value that agrees with my own "experiments": these days I'm using 2005 comparables, not late 2008 comps, in my Comparative Market Analyses, and they're proving to be remarkably predictive. At least I think so, and my buyers seem to like the results too. The sellers? Not so much.
So why buy a home in such uncertain times? I could tell you something theoretical that sounds suspiciously like a bumper-sticker slogan—"Uncertainty is the buyer's best friend"—but that's a tough sell, because buyers always prefer certainty and most won't make a move without it. Ironically, certainty is a false friend to the buyer because it turns a buyer's market into a seller's market, but conventional wisdom and native caution require that the buyer wait until Yahoo! Real Estate says homebuying is socially acceptable again.
I could also tell you that I put my 2008 IRA contribution into November 2008's extremely uncertain stock market instead of spring 2009's possibly slightly less extremely uncertain stock market, not because I know more about the stock market than the next guy but because real estate has taught me that markets over-react, going down as well as up. Yes, maybe I'll take a beating in the short run, but I'm in for the long haul, and I'll be there to enjoy the run-up when Yahoo! Finance says stock buying is socially acceptable again.
Yes, friends, I could tell you all that but, instead, I'll simply point to the average sales price trend line on the chart, especially to the low point in late 2001. Those of you who weren't in the local real estate market then, and perhaps weren't even in the area, will be blissfully unaware of the overwhelming feeling prevalent in Silicon Valley that the good times were over, for a long time and possibly forever, and that the bad times stretched before us like a vast and limitless Sahara of bust. Yes, most of us fell into the trap of thinking that the tech bust was different—just as the tech boom had been different—because, like the boom, it would never end. You might think the transitory nature of the just-ended boom would have taught us a lesson, but the famous last words of every bust as well as boom are always this time it's different!
So in 2001 most of us punished ourselves with the grim realization that the Valley had really bought it this time, and years and years of it. Yet by late 2001, just when things looked their darkest, homes began selling briskly for the first time that year. Why? Because by then enough sellers had finally convinced themselves that this time it's different! just as enough buyers had finally convinced themselves no it's not! or even if it is, at these prices I don't care! Because, as any agent who holds an open house in a midrange neighborhood can tell you, most people like these neighborhoods and many would like to put down roots in them. Two Sundays ago I held open a home in Menlo Park, priced in the low 900s, that's been on the market four months and still attracted 22 people. That's an amazing turnout for a listing that by all rights should be as stale as week-old bread. Low 900s is first-time buyer territory in Menlo Park, and first-time buyers have been largely out of the market since early 2005 and four years is a l-o-n-g time for people to defer their dream. All they're waiting for now is what the average home buyer always waits for: the flashing neon BUY NOW sign.
So why doesn't this home sell? Because it's typical of much of the midrange market. Yes, the home is priced for the pre-September market—the listing agent (not me) knows this as well as any buyer—but not by much, or it wouldn't attract so many buyers. The seller has reduced the price, but not by much, because the seller doesn't have a pressing need to sell. If he can't get his price, well, maybe he'll do what so many local homeowners did during the early 1990s: wait out the market by turning landlord. Do the numbers say that turning your home into a rental makes sense? I'm not sure they do, but that's not the point. The point is that barring some sort of economic catastrophe, either personal or regional, that's what sellers in this area have done, are doing and will continue to do.
Of course, that grim determination among sellers to stare down the market may weaken if things get really bad in Silicon Valley—if a combination of scary headlines and shrinking wallets finally convinces sellers that this time it's different! So, as always in markets like this, the next year or so will be a face-off between sellers holding the line and buyers who don't have to buy but sure would like to.
In the short run, I like the sellers' chances. But in the long run, there's always a few sellers who'll need to sell, and they'll blink first.