Has the market really bottomed?

With sales starting to creep up, both in California and in the Bay Area, the media is suggesting that we’re at or near the bottom of the real estate bust.

True or not, when Yahoo! Real Estate declares real estate a bargain, as it did May 30, 2008 then it doesn’t matter whether we’ve bottomed or not. If one of the most “mass” of mass media outlets sounds the all-clear signal for buyers, then happy times must be here again.

Why? Because much of the sales slowdown on the mid-Peninsula has been driven, not by the “unavailability of jumbo loans” (then why are my clients getting jumbos at near-historically low rates?) but by the public’s perception that now is a very dicey time to buy a home. It’s one of those periodic “only fools are buying houses” markets often mistakenly called a “buyer’s market”, mistakenly because buyers rarely buy in a buyer’s market even though the wind is finally at their back.

Buyers, particularly first-timers burdened with the usual concerns about homeownership—even first-time buyers looking in neighborhoods where foreclosures either aren’t happening or are a microscopic part of the inventory—have been freaked out by the media’s relentless drumbeat of foreclosure two three four foreclosure two three four. While foreclosures are still a serious—and ever-increasing—problem in some parts of the state, an up tick in home sales gives the media a new story to tell and sell, and the media loves a new story. In fact, I’m going to predict that we hear less and less about foreclosures even as they escalate, because foreclosures are beginning to commit the unpardonable sin of being old news, and old news is news that’s worn out its welcome with editors.

But the media’s expert blend of numbers and melodrama isn’t the only, or perhaps even main, factor holding back sales at the affordable end of real estate. Low-end buyers who, only six months or a year ago, the mortgage banking industry would have been all too happy to prop up in a corner as qualified buyers, are suddenly not qualified buyers—and may not be for a long time, if ever. When even bank-owned properties fall out of contract because their buyers can’t qualify for a loan, you know credit is tight at the low end. And why does “hoist on their own petard” come to mind?

If the affordable neighborhoods, so publicly steamrollered by the subprime crisis, start to recover, however slowly, then “bust” will fade from the 6:00 News and so from the consciousness of buyers in all price ranges, even in those where “bust” was far more a state of mind than a state of the market. This real estate recovery is going to have to start from the bottom up, so that Yahoo! and the other purveyors of mass info-tainment can quit wasting their precious talents on real estate and go back to doing what they do best: speculating on Oprah’s declining ratings, and restoring the good name of “Four vegetables that don’t deserve their bad rap”.

It’s my belief that pent-up demand for affordable homes (which, in this area, is anything under about $900k) is extremely strong, at least for stand-out properties. At a recent open house for a remodeled 1920s bungalow, listed at $898k, in an inexpensive but Norman Rockwell-esque part of San Mateo, I saw buyers crowd through as if it were a first-time open back in high-flying 2005, yet the home had been on the market for over a month, an eternity here, with no offers! A few weeks later I watched as young buyers overran a small Sunnyvale house priced at $529k with not much to recommend it except a large lot.  And last week I helped buyers who just six months ago were priced out of the market buy a modest but well-maintained single-family home in a good school district.

Which brings me to East Palo Alto, the mid-Peninsula’s most affordable city.

I don’t have any buyers or sellers in East Palo Alto and neighboring Belle Haven right now, but I’ve had in the past, and that plus the gut-wrenching changes in its real estate market keeps pulling me back to check the latest developments. Until lately, these developments were dire. But research for an article on home sales as a market indicator revealed a slim ray of hope: while East Palo Alto home prices had declined, catastrophically and seemingly overnight, East Palo Alto home sales were on the rebound!

My interest in this trend is partly analytical and partly what might be called humanitarian. Aside from my concern for a community that’s going through the kind of financial disaster and social upheaval that often leads to epic novels (a disaster, by the way, that’s elicited a resounding “huh?” from the local English-language media) the East Palo Alto market is an indicator of how real estate markets outside this area, such as in the hard-hit Central Valley, are likely faring. Because while East Palo Alto is an anomaly on the affluent mid-Peninsula, it’s a window onto much of California’s real estate market.

One caveat: unlike the Central Valley, but like most of the mid-Peninsula, East Palo Alto was largely built out by 1960, so it’s been spared the deleterious effects of the (over)building boom of the mid 2000s. While subprime is definitely a problem in East Palo Alto, overbuilding isn’t and likely never will be.

So what did I find encouraging in EPA’s numbers?

For one thing, East Palo Alto homes are beginning to sell, and that always a good sign. They aren’t selling in torrents, but for East Palo Alto real estate, even a heavy trickle is an improvement. Because if sales are the pulse of the market, until recently East Palo Alto was clinically dead. But if 2008 home sales continue at their present pace—and I think sales will actually accelerate, for reasons I’ll go into in a moment—then EPA will come close to reaching its 2005 activity level.

Aside from the obvious—if nothing sells, there’s no marketplace—what’s so promising about EPA’s upsurge in sales? Two things. First, inventory there had been piling up to an alarming degree. One agent who’s watched East Palo Alto for thirty years tells me it’s had more inventory lately than during the last major slump in the early 1990s. Rising inventory doesn’t just mean more competition among sellers for buyers, driving prices downward. It also pressures banks to list the homes they’re selling at ever lower prices, further encouraging them to cut and run regardless of the consequences to other sellers, although I doubt this is as significant as it’s been made out to be. I have trouble buying into the idea that banks—or real estate agents, for that matter—can manipulate real estate prices, deliberately or otherwise. Think of bank-owned property, rather, as a brick tied to the accelerator of the EPA real estate market as it races downward to find its new price level and you won’t be far wrong. Without bank-owned property East Palo Alto would still get there, just not nearly as fast.

But the increasing incidence of bank-owned property is, surprisingly, cause for much of the hope I have for East Palo Alto real estate. Since late 2007 a huge chunk of East Palo Alto inventory has been “short sales”, homeowners trying (almost always in vain) to get lender approval to sell for less than the loan balance. For reasons I go into in another article, short sales rarely sell, which means they hang around as virtually unsalable inventory until they go into foreclosure.

Unsalable inventory has three effects on a real estate market, none of them good. It:

exaggerates buyers’ perception that they have an endless supply of homes to choose from, which often paralyzes them
reinforces the idea that “homes aren’t selling”, which is self-perpetuating, and
acts as a huge floodlit sword hanging over the head of the market, further discouraging buyers from buying

Bank-owned property, on the other hand, creates the perception that:

the market is at or near bottom, and
there are bargains to be had

And because banks are (usually) motivated and business-like sellers, bank-owned properties do sell and relatively quickly, at least when their buyers can get financing. When homes in communities such as East Palo Alto start selling, they’re well on their way to what I suspect will be a surprisingly quick recovery, at least in high-demand areas like the mid-Peninsula, although at tremendous financial and emotional cost to many who live in affordable communities. Recovery in affordable neighborhoods means fewer dire headlines from them, which means less hysteria in every part of the marketplace.

To give you an idea of how likely East Palo Alto short sales and bank-owned homes have been to sell, compared to other sellers, I’ve compared total EPA single-family inventory for May 2008 to all forty-two closed EPA sales for 2008.


As I said, it’s been grim for short sellers. The ratio of May 2008 short sale inventory to 2008 closed short sales is about 20:1, or, in other words, a short seller has about a 1-in-20 chance of closing. The ratio of bank-owned inventory to bank-owned closed sales is about 3:1, “other” (conventional sellers) about 1:1. As short sales morph into bank-owned property, the log jam will break, homes will begin to sell and the market will begin to heal.

At this point you might have two questions.

“Why don’t you compare May inventory to May sales, instead of to total 2008 sales? Wouldn’t that give a better picture of the current market? Huh? Now wouldn’t it?” Ordinarily I’d be happy to, because of May’s twenty-three sales, over half (twelve) are bank-owned property, and that’s a good picture of the direction the EPA market is heading. On the other hand, of those twenty-three sales, seven are pending short sales, and only one short sale is a closed sale. Based on what we’ve seen, those six pending short sales may well never close, so it’s premature to count them as success stories. The ranks of EPA homes taken off the market unsold are littered with short sales once listed as “pending sales” while lenders let their borrowers and potential buyers twist in the wind.

“The real estate market is on the mend, fine, but what about all those homeowners who lost their homes? When are they going to heal?” Good question. There’s a school of thought that says these folks are either fools getting their just comeuppance or crooks playing the system like a slot machine right up to the moment they get kicked out of their homes. I have a hard time buying either, not because of my faith in mankind, but because I seem unable to see the world in the black and white of the serial moralizer.

What else do I see that promises a slightly brighter future for EPA real estate? A few more indicators that may seem insignificant but aren’t.

In January 2008 a staggering 112 East Palo Alto homes were taken off the market unsold. Bear in mind that there were “only” 191 homes on the EPA market that month. And only (no quote marks this time) five homes sold in January 2008. That bears repeating: a whopping 191 homes on the market, of which a whopping 112 (59 percent) were taken off the market unsold, with an un-whopping (anti-whopping?) 5 sales. These are shocking, even mind-bending, numbers. I’ve never seen numbers that bad.

But it’s getting better. May 2008 saw a paltry twenty-six properties pulled off the market unsold, while a rousing twenty-three sold. That 1:1 ratio still isn’t reason to break out the champagne, but it’s much much better and, in fact, a surprisingly good number.

And because sales have picked up dramatically, inventory measured in “months of inventory” has gone down dramatically. Months of inventory is a theoretical but popular measure of inventory (and market tempo) that calculates the number of months it would take to sell existing inventory at the current rate of sales if no other homes came on the market. Of course, other homes do come on the market, even in a market in much better shape than the EPA market, but it’s a quick way to gauge the strength of any market. January had almost three years of inventory which, as even the casual observer might guess, is way way too much inventory. May, on the other hand, had “only” eight months of inventory, which still indicates an extreme buyer’s market (but only by this area’s standards) but shows a remarkable, no, extraordinary, improvement.

In addition (and not coincidentally) bank-owned properties have increased in what I guess we’ll call “market share”.


In January 2008 bank-owned homes accounted for about 6 percent of EPA inventory, while short sales made up 31 percent. In May, the numbers rose to 23 percent and 58 percent respectively. Yes, short sales now comprise an additional 27 percent of inventory, even as bank-owned homes make up an additional 17 percent and the percentage of “other” sellers has declined. But at least total inventory increased only incrementally, in what might even be a normal seasonal shift. Two steps forward, one step back: we’ll take it.

So it’s clear that all is not sweetness and light. The distress subprime is causing communities like East Palo Alto is obviously far from over. My guess is that it won’t be until bank-owned properties outnumber short sales. That’s one market indicator well worth watching.

copyright © John Fyten 2008

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