Investing in Silicon Valley real estate.

Over the years, Silicon Valley real estate has paid off handsomely for investors.  But there are three common misconceptions that can trip up beginners.

“There’s an ideal time to buy.”  I discussed this last month, so I’ll just say here that 1) the ideal time to buy is when no one is buying, and 2) very very few people, especially beginning investors dipping a toe in the water, are willing to buy when no one is buying.

So it’s simple:  the ideal time to buy is when you can afford to buy, regardless of what’s going on in the marketplace.  And as I said in August, you beat the Silicon Valley real estate market by joining the Silicon Valley real estate market.  You get on the train everyone else is on, and you stay on, through the ups and downs.  This is buy-and-hold investing, not day trading.

Then there’s the idea that you should invest in undiscovered gems:  neighborhoods that no one knows about, neighborhoods that are under-appreciated by the rest of the market.

There are no undiscovered gems in Silicon Valley real estate.  For five years–no, make that 20 years–home prices have risen rapidly while thousands of home buyers have put the Valley under a microscope looking for undiscovered neighborhoods that give them the premium features they want for less.

Those bargains don’t exist.  Sure, Silicon Valley has relatively cheap neighborhoods, but they aren’t bargains.  They’re cheap because they have very real drawbacks that limit demand and, therefore, price and upside potential.

But that can change, right?  If a cheap Valley neighborhood is in a great location close to high-paying jobs, doesn’t that mean that pretty soon it’ll sell for as much as those expensive neighborhoods just a stone’s throw away?  Aren’t all these micro-neighborhoods and bewildering variations in property values mile by mile and block by block just an accident of moldy history, irrelevant in this enlightened day and age, and undoubtedly due to boomer mismanagement of the world in general and Silicon Valley in particular?

Isn’t there an app for that?

You could hold a graduate seminar on this, but instead let’s look at the city with perhaps the strongest brand in the Valley, Palo Alto.  Palo Alto has:

  • a tradition of putting big money into infrastructure like schools, parks, libraries and public recreational facilities that goes back one hundred years
  • a reputation for education excellence that goes back at least to the 1960s, and has international recognition
  • a regional downtown, a destination that regularly draws people from throughout the Bay Area and, indeed, the world
  • a world-class university next door that has made a huge contribution to the economic, cultural and intellectual environment of the city
  • a long tradition not just as a tech center, but as one of the addresses in the tech world
  • a long tradition of effective community activism
  • a long-standing reputation for offering superior quality of life
  • a track record of spectacular increases in property values, coupled with occasional relatively mild downturns, that has given rise to the myth that Palo Alto prices never go down

Can your brand say that? 

If it can’t, you’re probably in for a very long wait until that cheap city or neighborhood with huge upside is “the next Palo Alto”.  But your grandchildren will be grateful for your foresight.

Here’s what fools neophyte investors:  a Silicon Valley real estate boom is a rising tide raises all boats, which makes all boats look the same, each seemingly with equal price appreciation potential and equal price stability.

But here’s how it really works.  In a real estate boom, home prices go up first in cities like Palo Alto.  Then, as home buyers get priced out and look for alternatives, they shift their focus to other, slightly less desirable cities.  That ripple displaces other buyers to even less desirable cities, until eventually prices begin to skyrocket in places hours away from core cities–places that until well into the boom weren’t on anyone’s list.

So what’s the downside to Plan B or Plan C “drive until you qualify” cities?  Some of those rising boats turn out to be watertight, others turn out to leak like a sieve.

In a downturn, demand shrinks–home buyers are far fewer, those few have far more choices, and those choices come at reduced prices.  We saw this during the last downturn.  That new home in Modesto, “bargain-priced” as an investment or primary residence because Modesto was everyone’s Plan B or Plan C, was hot! hot! hot! in 2005, and suddenly not! not! not! in 2006.  Prices cratered by 50 percent or more almost overnight in second-, third- and ninth-choice cities because more buyers suddenly had more options, closer to jobs, in the cities and neighborhoods where they really wanted to live, and at reduced prices.  Those Plan A cities also saw price declines, but they were relatively mild.

But cities that had been acceptable substitutes only when prices were high and going higher crashed early and hard, and took years to recover.  That’s not the kind of track record most investors look for.  That’s junk grade, not blue chip.

The third fallacy is that single-family homes are a better investment than condos and townhomes because with single-family you get land! land! land!  A look at some of the price trend charts elsewhere on this site should convince you that condos and townhomes in high-demand cities like Mountain View fared better over the downturn than single-family homes in affordable areas like East Palo Alto and Menlo Park’s Belle Haven.

Why?  In Silicon Valley, price stability depends more on perceived desirability than land.  Yes, land is important–if it’s in a neighborhood widely perceived as desirable.

Still not convinced that location trumps land?  You can make a convincing case that in the Valley today “luxury” depends more on location than on high-end finishes.  A tired condo in a great location, close to transportation, jobs and a vibrant downtown, is a better investment than a new home that isn’t.  A contractor can upgrade a condo in a week.  But no contractor can upgrade a location.

Yes, it’s still “location, location, location”.  But that’s just another way of saying “desirability, desirability, desirability”.  Which is another way of saying “brand, brand, brand”.

Not every city or neighborhood has a strong brand.  Those that do aren’t cheap.  Those that are cheap aren’t bargains.

copyright © John Fyten 2017








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