What happens in 2013?

What happens in 2013?

2012 is a tough act to follow, but I think 2013 will be the year to do it—minus 2012's shock and awe. Why? Look at my most recent newsletter and you'll see that absorption and days on market, the two most accurate indicators of what real estate will do in the short term, are far hotter in virtually every local market I track—absorption of inventory is higher, days on market lower—than it was at this time last year. Why do I think that's telling? Because market activity at this time of year is itself an indicator, of the following spring's activity, and how Spring 2013 goes is most likely how the rest of 2013 will go. Late 2012 looks like the launching pad for a hot spring and a very strong 2013.

Yes, Spring 2012 seemingly came from out of nowhere, although there were signs at this time last year that the midrange and even the long-suffering low end were having some kind of rally, while traditional forerunners like Palo Alto and Cupertino had been recovering nicely since 2010. But it's been my experience that Silicon Valley real estate booms do come from out of nowhere (except history) unless you're active in the market, which is why it's so difficult—and dangerous—to try to time this market. Not that anyone will stop trying.

Now that we're entering year one to year three, depending on price range and housing type, of this latest recovery, things will be a little different. First, no one will be surprised by a very active spring market this year. At least, I hope they won't. Yes, there's big uncertainty out there, and uncertainty affects markets, but I seem to recall big uncertainty at this time last year. And, yes, I know that some huge market-shifter can show up, something like the invasion of Iraq that stalled real estate from late 2002 to mid-2003. Some may even think they know what that market shifter is—an air strike on Iran's nuclear facilities seems the most likely to me, or perhaps worsening recession in Europe—but let's acknowledge that it's a wild and wooly world and move on. Many home buyers did just that last year.

So if rates are low and times are good for Silicon's Valley's technical elite and ancillary industries throughout 2013, I'm guessing—sorry, predicting—another round of price appreciation in the 10-15 percent range. Oh yes, I almost forgot one key factor in 2012's price rise: inventory. Specifically, lack of inventory. Specifically, way way more buyers than sellers. I think that's going to be a factor—bonus if you're a seller, bummer if you're a buyer—this year as well, despite rising prices that, theoretically at least, should coax more sellers into the market.

People wracked their brains trying to figure out why inventory was so low in 2012. For a while we could blame the media: "Home Prices Back to Stone Age Levels". Sounds like a fun time to sell, right? But lately even the media seems to have noticed that real estate, in particular Silicon Valley real estate, is on fire. So I'm guessing that anyone who owns a TV knows that now is a pretty good time to sell. Actually, it's a fantastic time to sell, but you're not going to hear that from any news anchor, so I'll give potential sellers another year or two to let it sink in.

But when you look at where home prices were at the beginning of 2012, even in many Silicon Valley markets, the Mystery of the Missing Inventory is solved. In all but a handful of local markets, prices were back to about what they were in 2004 or 2005. Which means that in January 2012 there were an awful lot of homeowners with little or no equity. As we'll see, that's changed in all but the hardest-hit markets, although equity still won't be abundant in 2013 for homeowners who bought in the mid 2000s.

This chart shows how far from the previous peak 2012 average prices are in almost all the Santa Clara County markets I track.

One of the few exceptions, top-end Palo Alto, exceeded early-2008 prices early in 2011—a bellwether sale in Professorville on Tasso confirmed that we were back on the plus side, and prices for prime Palo Alto properties soared through 2011 even as they declined at the low end. Three years of trough isn't bad when most local markets went through six.

The next chart, showing the percentage difference between peak and 2012 average prices, seems to indicate how much further many markets have to go before the typical homeowner who bought in the mid-2000s won't have to bring money to the table to sell. Remember, 10 percent or even 0 percent down payments were common then.

Next, here are the markets I track in San Mateo County.

And the percentage difference between the previous peak and 2012 average home prices.

Yes, every San Mateo County market here was still below its peak, and the more affordable the neighborhood, the bigger the negative. But wait!, you (should) say, aren't these charts based on annual average sale prices, and doesn't your newsletter chart show prices going up at a steady clip all year? So aren't we really looking at the situation as it was mid-2012, not at year end?

Good catch! Yes, 2012's refusal to cool down over the winter like a normal market means that there's more equity here than meets the eye. In fact, a quick check of Q4 prices suggests that the markets that appear to be about 5 percent below peak are actually at peak or above right now. Markets shown as much as 20 percent below peak are actually close enough to peak now to equal or exceed it by next summer, given a rousing 2012-style spring. Any markets more in the hole than that are probably going to have to wait until 2014 to equal or exceed previous peaks.

Whether this outburst of home equity will allow, let alone convince, homeowners to sell is hard to say. It should, although I wonder if the effect on inventory will be dramatic—and when there are so many offers on so many properties, it'll take a dramatic increase in inventory to cool off price appreciation. And you don't just decide one day to sell your house like it was 100 shares of Apple. It gets complicated, especially when other stakeholders—spouse, kids—have a say. Then there's good old inertia, and seller market timing ("I'll wait until it's an even better time to sell"), and...

So do I really think prices will go up in 2013 like they did in 2012? Yes, I do. Prices are still so depressed at the low end that it's cheaper to buy than rent, not a normal situation for this area. Are low-end neighborhoods grossly under-valued? Yes, I think they are, based on the historical price relationships between low-end and midrange markets. Investors think so too, and prices still make sense to the first-time buyers we need to supplement investors.

Is it inevitable that all home prices, low end, midrange and top end, return to and even exceed their previous peaks? Yes, I think so, at some point, barring catastrophe and depending on the neighborhood. The real question is when. Midrange SFRs will probably set new price records this year, as will condos and townhomes in sought-after cities such as Menlo Park and Cupertino. But traditionally affordable cities and neighborhoods such as East Palo Alto, north Sunnyvale, downtown San Jose and Redwood City east of El Camino probably won't be completely back for another year or more. Will this boom cycle (and the Fed) give them that much time? The two previous booms lasted at least five years each, and up to seven in places like Palo Alto and Los Altos. If history repeats itself, and I wouldn't bet against it, we'll see new price records across the board.

Prices go up in this area, not just in the short term but in the long as well. In all local markets except the ultra-top end, prices are higher today than they were at the peak of the dot-com era, and far higher than they were in the mid-1990s. Anyone who's "waiting for the market to cool off" before buying has a long and expensive wait, if history is any guide. The appreciation of 2012 and 2013 is the appreciation that typically hangs around through thick and thin and makes homes here more expensive than they were ten or twenty years ago. It's the appreciation later on in the up-cycle that may or may not survive the next downturn.

Eventually, all but the most confirmed fence-sitters realize a boom is real. Unfortunately, some of them don't realize it until just before the next bust.