Maybe it’s me, but someone doesn’t get it.

Maybe it’s me. Maybe I’m too close.

But maybe it’s the economists. Maybe they’re too far away.

If it’s the economists who don’t get it, then the latest evidence is a recent pronouncement by one Christopher Thornberg, former senior economist with the UCLA/Anderson Forecast, now founding partner of Bay Area real estate research firm Beacon Economics.

I first heard of Thornberg—as many in the Bay Area undoubtedly did—when he declared during a February 16, 2008 KGO-TV news report that “the reality is [home] prices are going to fall 35 percent in the state and in the Bay Area. I suspect they are going to fall between 25 and 30 percent before this is all over”.

Hi folks, I’m Christopher Thornberg with Beacon Economics. That’s Beacon Economics.

Well, I hate to pick nits, Thornberg, but what’s it going to be? How much are home prices going to fall? “35 percent”, or “between 25 and 30 percent”. It isn’t often that even an economist contradicts himself in consecutive sentences. If my home is worth $1M today, will it be worth $750k “before this is all over”? Or will it be worth just $650k? Or maybe $700k? This from a guy who, according to a blogger fan, is “rigorous”. This from a guy who, in a December 28, 2007 opinion piece for the Los Angeles Times sternly instructs homeowners to “be realistic” in “your expectations of your home’s value so that it’s correctly aligned with market realities…and factor those declines in”. Hey Chris, I do want to be realistic. So help me out. Which one of your declines do I factor in?

How does Thornberg justify this prediction? Does he justify this prediction? Sure, maybe KGO-TV cut that part (or, more likely, never asked the question) but in his Times piece Thornberg predicts a “25% to 30%” decline (“probably”) also without sharing where he gets these numbers.

Maybe it’s just me, but is this rigorous science? Maybe it’s just me, but is this rigorous journalism? Maybe it’s just me, but is it any wonder that people believe only the economic predictions that happen to fit their preconceptions? What else do they have to go by? Hard science? In-depth reporting?

KGO-TV’s report has Thornberg advising sellers “to sell as fast as possible because prices will only drop even more”. Panic-selling as a market exit strategy. Homes not selling in your area, folks? Then get your home on the market now so you can drive down prices even more. You heard it here first.

Hi, Christopher Thornberg here with Beacon Economics. That’s B-e-a-c-o-n Economics.

Whenever an economist lets loose a sky-is-falling salvo in search of a sound bite, I can only wonder what public reaction would’ve been had the National Association of Realtors® come out in 2005 and urged buyers to “buy as fast as possible because prices will only go up even more”. Unconscionable! Irresponsible! But contrary to Internet urban legend, NAR didn’t say that. In fact, back in 2005 NAR warned that the boom couldn’t go on forever.

Of course, the perceived difference between an economist and NAR is that NAR is a trade group notorious for having the interests of the real estate industry at heart. The economist? Well, most of us seem to think that economists go around making predictions simply out of the goodness of their hearts. Knights errant of the modern landscape.

But isn’t it interesting what a big splashy prediction can do for the visibility of a certain economist? A certain economist who just went out on his own as founding partner of a brand-new real estate research firm? A brand-new real estate research firm that could use some free publicity?

That’s Beacon Economics, folks. B-e-a-c-o-n. Operators are standing by.

Think Thornberg and his B-e-a-c-o-n Economics would make the local nightly news if he said, as did UC Berkeley Fisher School of Real Estate’s Kenneth Rosen—not exactly a lapdog of the real estate industry—in a November 27, 2007 Los Angeles Times interview that “values in [the Central Valley and Inland Empire] could fall by 15%”, and that “in areas where there is very little new housing, where it’s hard to build and a lot of wealthy people live, there will be little decline or maybe none at all”. Areas like the core Bay Area, Ken? Areas like the better neighborhoods of San Francisco, which was largely built-out by 1940? Areas like the move-up neighborhoods of the mid-Peninsula, which was largely built-out by 1960?

I guess the reasoned pronouncements of a Ken Rosen are bor-ring! if you’re a news producer. Old hands like Ken, who’s apparently learned the hard way that local real estate has a few nuances up its sleeve. Old Ken, always good for a nice hair-raising quote until he moderated his stance. There’s a lesson here for you ambitious economists.

Thornberg is eminently quotable because he refuses to differentiate between entry-level markets fueled during the boom by risky lending and those further up the price range that weren’t. No, nuances like this just get in the way of a nice sweeping generalization, and it’s sweeping generalizations that thrill and chill readers and viewers. The entire house of cards will fall, claims Thornberg in the same Los Angeles Times interview which quotes Rosen. “Every place takes the hit in the long run.” According to him, “if prices in high-end markets do not bend while prices fall in adjacent areas, many buyers will at some point choose the cheaper neighborhood”.

Yes, it’s a plausible theory, one that makes sense to the man in the street—which should raise a red flag when a highly-nuanced subject is discussed, because it suggests it’s probably a theory that’s at least simplistic and quite possibly not true. After all, what distinguishes science from casual opinion, what distinguishes the economist from the man in the street? A body of work informed with nuance, a complete understanding of those nuances, mysteries unlocked only after careful and intelligent study.

At least, that’s the idea.

You’ll find the theory of substitute goods which Thornberg applies to real estate in economics textbooks—and reading all those economics textbooks is what makes economists smarter about real estate than anyone else.

Well, maybe it’s just me, but that’s not how the market is panning out these days, and I don’t think that’s how the market will pan out down the road. Why won’t I kowtow to the superior wisdom of an economist? Two things. Experience working with buyers for move-up neighborhoods; I’ve probably worked with more than Thornberg has. And statistics. Yes, I have statistics too, just like the big kids.

First, some of that experience. These days I’m working with three couples looking to buy in the kind of move-up neighborhoods Thornberg says will go down just as hard as entry-level neighborhoods. Working with these buyers is fortuitous and no, not just because move-up neighborhoods mean higher prices and therefore bigger commission checks. It’s fortuitous because buyers for move-up neighborhoods are about the only buyers actively looking these days, at least in my neck of the woods.

Hmm. Might this activity suggest, just by itself, that entry-level and move-up neighborhoods are reacting, and may continue to react, differently to the market slump?

But wait, there’s more! Let’s see why these buyers are focusing on move-up, rather than entry-level, neighborhoods. What benefits do move-up neighborhoods have that attract these buyers? And conversely, what benefits do entry-level neighborhoods lack, or what detractions do they have, that repel move-up buyers?

Let’s meet move-up buyer Couple A, who seek a new or remodeled 2000-sq.ft. home in an elegant, prestigious neighborhood where a woman can feel comfortable walking. Here’s their background. Couple A are successful professionals who’ve owned their own relatively modest homes (they’re combining households) for well over ten years. In the jargon of the real estate business, Couple A are “move-up buyers”: life’s early dues have been paid, and the reward for years of professional and personal achievement is a gracious home they can enjoy for the foreseeable future, perhaps forever.

But unfortunately for Couple A and the many other buyers like them on the mid-Peninsula, inventory is very tight in move-up neighborhoods these days because a) virtually no one’s getting foreclosed on in those neighborhoods, and b) virtually no one’s getting laid off in those neighborhoods, and c) buyers don’t know that they shouldn’t be snapping up these homes, and d) the media and certain economists are telling everyone, no matter what kind of neighborhood they live in, that real estate is in the tank, and who wants to sell their home when real estate is in the tank?

So one-hundred seventy-five buyers and assorted tire-kickers go through an open house in a move-up neighborhood because there’s lots of people like Couple A and very few homes for them to look at.

Next I’ll introduce move-up buyer Couple B. Couple B own their own home in a pleasant neighborhood at the high end of entry-level and so far unaffected by the subprime mortgage crisis. Couple B wants much the same house as Couple A but with two exceptions. One, schools are important, which doesn’t really change things much, because highly-regarded schools usually go with highly-regarded neighborhoods, and highly-regarded neighborhoods are move-up neighborhoods. Two, Couple B is looking in a different city, one where their relatives live and beckon, which we’ll call Wonderfulville. Wonderfulville is known and has been for years, nationally and even internationally, for its wonderful infrastructure and quality of life. Hence the name.

Inventory is quite tight in Wonderfulville. Reasons? See above.

Last up is move-up buyer Couple C, also looking in Wonderfulville, and even in the same neighborhoods, and for much the same reasons, but in a lower price range. With four kids, schools are important to Couple C, but lifestyle is too. Even though Couple C doesn’t live in Wonderfulville, like many they frequently enjoy its downtown and many other amenities. Couple C now lives in a nearby city that’s often seen by buyers as an acceptable (and much cheaper) substitute for Wonderfulville. We’ll call this acceptable-substitute city Justasgoodas. Yes, Justasgoodas offers everything Wonderfulville does—well, just about—for a lot less money. You bet. Funny thing is, though, many of the people trying to buy in Wonderfulville live in Justasgoodas. And no one who lives in Wonderfulville is trying to buy in Justasgoodas. Which makes you wonder how acceptable a substitute Justasgoodas really is, once you’ve lived there a while and the new-car smell wears off.

Hey! Here’s an economic theory of my own: maybe cheaper home prices mean you get less good stuff. And maybe—I’m going out on a limb here, but work with me on this—people who have money want more good stuff and are willing to pay for it and in fact won’t settle for anything less!  Just like in real life! Whoa! What if real estate somehow resembled real life?!

A dangerous and upsetting economic theory, one that probably wouldn’t survive peer review.

But it may well answer the burning question, “Why aren’t move-up buyers poking around in entry-level neighborhoods where there’s plenty of inventory, in fact, more than enough inventory, in fact, way too much inventory, so much inventory that prices are falling?” If low supply and high demand are keeping move-up neighborhood prices elevated, why don’t move-up buyers get wise and do what Thornberg says they’ll do: move down a notch or two in price?

So far they haven’t, and I don’t think they will, which raises a larger question: why don’t buyers ever do what economists think they should? Why do participants in the real estate market persist in cruelly disappointing economists? Why is it only the non-participants in the real estate market, the people permanently planted on the sidelines, who heed the economists’ advice? (And does this raise an even larger question about the efficacy of that advice?)

Boy, home buyers must be as clueless as the economists and bubbleheads say! That’s certainly a popular notion, especially among people like economists and bubbleheads who keep the real estate market at arm’s length. Maybe it’s just me, but I don’t think it’s the move-up buyers who are clueless.

Maybe move-up buyers will hold out for the move-up neighborhoods they want:

Because entry-level neighborhoods aren’t elegant. The vast majority never were.
Because entry-level neighborhoods don’t consistently have large, elegant homes. Why not? Because people who can afford large, elegant homes don’t buy in entry-level neighborhoods, so builders don’t build large, elegant homes there. Because people who do live in entry-level neighborhoods and become more affluent almost always leave instead of building new or expanding.
Because entry-level neighborhoods usually don’t have sought-after schools. Why not? Because sought-after schools mean high-priced neighborhoods, which means move-up neighborhoods.
Because entry-level neighborhoods often have a history of being short-changed on infrastructure like shopping, parks and the other amenities that attract affluent buyers.
Because in any slumping market, no matter what that market is, buyers seek established investments with strong brands. It’s called “flight to quality”. Move-up neighborhoods have strong brands. Entry-level neighborhoods don’t.
Because many buyers perceive a correlation between neighborhood home price and neighborhood safety.
Because move-up buyers often already live in entry-level neighborhoods. Been there, done that, got the t-shirt. Why move to another entry-level neighborhood? Just to keep the moving companies busy? Time for bigger and better things.

It’s like this: you’re driving a Chevy and you decide you need and can afford a car with more style, refinement and prestige (and maybe some of that pampering you’ve heard the ritzy dealerships give their customers). You’re not going to buy another Chevy, no matter how many rebates they pile on it. You probably won’t even know that Chevies have rebates. Because you don’t care about Chevies anymore.

That’s why move-up buyers aren’t looking in entry-level neighborhoods. Not now, and not enough of them in the future to bring down move-up prices.

Well, okay, you say, that’s all well and good. But that’s just your experience. And, you add, no offense, but I notice that you’re a real estate agent. You don’t roam the country, noble-knight like, warning people of danger, like the pure-hearted economists do. Give me data, ’cause data don’t lie.

Okay, let’s look at three different statistical slices of the mid-Peninsula real estate market. The first slice I’ll call “SMC east” because it’s comprised of the entry-level neighborhoods of San Mateo County east of El Camino or east of 101 or both. These neighborhoods are called “entry-level” because many people starting out buy their first single-family home in these relatively affordable neighborhoods. It also sounds better than “cheap” and, in fact, there are no cheap neighborhoods in this area.

The second slice will be the first tier of move-up neighborhoods. I’ll call them “midpenmidrange”, for “mid-Peninsula midrange”. These neighborhoods are located in Mountain View and in the so-called “affordable” neighborhoods of Palo Alto and Menlo Park where “affordable” means “less than $2M but not by much”.

The third slice is a market I haven’t mentioned so far, the price range above “midpenmidrange”: top-end neighborhoods that sell for $2M or more and usually much more. I’ve put the best neighborhoods of three genteel ultra-affluent communities—Woodside, Portola Valley and Los Altos Hills—together with Palo Alto Hills to create what some call “exurbia”: beyond the suburbs.

I’ll chart how these three markets have reacted to various recent milestones—high points and crisis points—in local real estate. We’ll be able to see if these markets, so different in price range, react differently to boom and bust, or even have their own booms and busts.

First let’s look at if, and how, average sales price has varied in these three local markets.


Right off you’ll notice that the trend line for all three markets is up. Doesn’t this prove Thornberg’s contention that they’re all the same market?

If Thornberg is right, every neighborhood, city, state, regional and national market that’s gone up over the past ten years is all the same market. The Sauk Centre market is just the Soho District market is just the Detroit market is just the Midtown Palo Alto market is just the Texas market is just the UK market is just the…and whether you live in a boom town like Yakima or a bust town like Grand Rapids, you’re goin’ down! Never mind that buyers for Santa Clara, fifteen minutes south of Palo Alto, and buyers for San Mateo, fifteen minutes north of Palo Alto, differ markedly from Palo Alto buyers. No, it’s all one monolithic real estate market, with identical buyers and sellers and identical economies, pumped up or laid low by identical market movers. Which a) denies the generally accepted view that real estate is local, and b) seems to be what Thornberg is saying.

And in fact, it is what Thornberg says in the Times opinion piece I mentioned. Thornberg scoffs at “‘experts’ out there…who preach that all real estate is local and that prices in your neighborhood won’t be affected by foreclosures and price declines elsewhere”. Well, this certainly simplifies the study of real estate economics. Rid the field of one pesky nuance and all the economists get to go home an hour early.

It’s also typical of the economist’s attempt to justify his work and existence. Unless he can reduce the marketplace to a few arcane mathematical models, the economist loses his tenuous pretense to science. Lose this, and his pronouncements would sink to the level of mere opinion, and sometimes ill-informed opinion at that. Which would put the economist on the same plane as the man in the street he supposedly instructs. Which would make the economist useless or worse, mere opinion and ideology masquerading as take-it-to-the-bank fact. Nuances—the human element, the differentiating characteristics of certain buyers and sellers as groups at certain moments in certain marketplaces—are disdained by the economist because he can’t plug them into his equations. The economist rejects nuances with a clear conscience because he works with equations, not humans, and so is unaware that humans bring nuances to the marketplace.

Let’s glance at the average sales price chart again:


See how differently prices in each of the three local markets we’re following have reacted over the last ten years? Note, for example, the spike in exurbia prices during the dot-com boom. Yes, prices rose in the other two markets as well, but not nearly as dramatically. That’s because much of dot-com’s mega-buck stock-option wealth was plowed into the home prices of top-end neighborhoods. Midrange prices rose less steeply because they were driven less by sudden and great wealth and more by the high wages and buoyant optimism of the traditional real estate boom. Entry-level east SMC prices went up as well, but much more gradually.

Why did the intensity of each market’s response to the dot-com boom differ so drastically? The top 20 percent of Silicon Valley income earners benefited far more from dot-com than the middle 60 percent or bottom 20 percent, which meant that home prices in the neighborhoods where the top 20 percent congregated benefited far more. The highly-educated elite that drove and was driven by the boom squeezed into a limited number of prestigious top-end neighborhoods, boosting home prices in those neighborhoods disproportionately.

You can see that these three markets reacted even more variously to the dot-com bust. Exurbia’s prices, fueled during the boom by a sudden injection of dot-com money, went into withdrawal when this money disappeared. This is a key point, because the infusion of dot-com funny money in the late 1990s and its abrupt removal in 2001 is analogous to the injection of easy credit into the entry-level market in 2005 and 2006 and its abrupt withdrawal in 2007. But in 2001 prices in the entry-level markets of east SMC actually went up just as exurbia’s prices cratered. Midrange neighborhoods were somewhere in the middle.

One final observation: midpenmidrange prices rebounded quickly and had exceeded their previous Q1 2000 peak by Q1 2004, while exurbia’s prices have never regained their dot-com heights. Entry-level east SMC prices, on the other hand, didn’t peak until Q1 2007, seven years after dot-com and exurbia crested.

So, yes, it does look like sales prices in each of these three price ranges have reacted differently to economic (and political) events since 1999. Which not only shoots a ragged hole in Thornberg’s contention that all price ranges are inevitably joined at the hip, but also suggests that these ranges may again move separately.

Next let’s look at what I think is the most important indicator in real estate, the thermometer that tells us the market’s temperature, absorption.


The absorption chart gives us even more dramatic evidence, not just of how these three local markets weathered 1999 to 2001, but of how they’ve responded to the current downturn—which hasn’t uniformly been a downturn. Those of us who remember the Oklahoma Land Rush atmosphere of early 2000 can well believe that relative demand rose sharply in exurbia during the feverish months of Q1 2000, and almost as sharply in midpenmidrange. Just as significant is the fact that relative demand in east SMC stayed flat while skyrocketing in the two higher tiers. Notice also that east SMC absorption plummeted from Q1 2005 onward, suggesting that the local entry-level market was showing signs of distress two-and-a-half years before the subprime mortgage crisis. In sharp contrast are the relatively stable or upward trend lines of midpenmidrange and exurbia since that time.

Again, we clearly see at least two distinct markets in motion here—midpenmidrange/exurbia and east SMC—over the past ten years.

The same is true of inventory…


…and of average days on market (with midpenmidrange paralleling first east SMC, then exurbia)…


and average bid, over or under list price.


Sales seems to be the one indicator where all three markets marched in unison, yet as I’ve said before, sales is the most deceptive of market indicators. Sales are down in east SMC because demand is down. Sales are down in exurbia and mipenmidrange these days, not just because demand is down but because, as the inventory chart shows, inventory is down. If fewer homes are on the market, fewer homes will sell, even if relative demand (the proportion of buyers to sellers) increases.


All of this—the anecdotal evidence, the charts—suggests that Thornberg’s theory of acceptable substitutes plays better in economics textbooks than in the real estate marketplace. I’m also going to suggest that this ivory tower myopia is not atypical economist behavior. Which explains why the real estate market continues to baffle, elude and generally bamboozle the economist. Not that this is ever due to the shortcomings of the economist, of course. No, to the economist it’s simply proof that real estate is an irrational marketplace, swayed by irrational sheep, sheparded by an irrational industry.

Will any of this get me on the nightly news? No. For one thing, it won’t fit in a ten-second sound bite.

Would I ever want my thoughts to be reduced to a yummy bite-sized sound bite? Maybe it’s just me, but no thanks. Drab anonymity is my game.

That’s Beacon Economics, folks. B-e-a-c-o-n.

[Note: In late 2008 the market for move-up homes ground to a standstill, just as Thornberg predicted, but not for the reason he gave: that buyers would avoid move-up neighborhoods in favor of cheaper neighborhoods that had experienced greater price declines. The real reason, of course, was one that only a handful of diehard pessimists claimed they saw coming, the credit crisis that eventually derailed the stock market. It’s well-known around here that the local move-up market follows the Nasdaq up or down, and in late 2008 it did so yet again. Thornberg’s theory of substitute goods had nothing to do with it.]

copyright © John Fyten 2008

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