Top end still hale, and a faint glimmer of hope at the low end.

Special report.

Top end still hale, and a glimmer of hope at the low end.

Unaffordable neighborhoods continue so, while affordable neighborhoods begin to show a faint pulse.

Anyone who thinks the real estate market in this area is unrelieved doom and gloom, with prices crashing in every neighborhood, should check out the chart below, which compares average home sales price for the period January 1-May 31 over the past four years, in five local markets.

And anyone who thinks that real estate doom and gloom is confined to exotic locales like Modesto and Las Vegas should also check out the chart.

Yes, Palo Alto single-family home prices have actually risen this year, from their already exalted levels, typical of local top-end communities and neighborhoods. Yes, prices for Mountain View condos and townhouses and for single-family homes in the city of Santa Clara have declined only slightly this year, typical of these kinds of housing stock in these kinds of local communities and neighborhoods. And, yes, prices in Menlo Park east of 101, East Palo Alto and Central San Jose have nose-dived—all-too-typical of affordable communities and neighborhoods in this area.

For this, my second special report on the local market, we'll focus once more on the low end, in particular Central San Jose.

We'll focus on the low end because that's where the bad real estate news comes from these days. Bad real estate news means scary headlines, which rivets the news-driven segment of the market, particularly first-time home-buyers, to the fence. Bad real estate news also makes lenders flinch, especially when they're the source of most of it, and tighten their underwriting guidelines—although I'll continue to insist that, based on my own clients, anyone with good credit scores and a decent down payment can still get a home loan at a great rate, and the new FHA-insured conforming jumbos seem to eliminate the need even for a decent down payment.

We'll focus on one particular part of the local affordable real estate market, the core downtown area of Central San Jose, for two reasons. First, I have buyers, grad students at a local university, looking for a home in a price range that for several years was submerged by rising prices and has only recently re-emerged, the under-$500k single-family or duplex market. That's the kind of property I mostly sold as a new agent, but that was ten years ago and two booms ago and two busts ago, and it's a real trip down Memory Lane to see real homes under $500k—like walking onto a used car lot and finding that $500 will get you some mighty fine iron.

The only place around here where you can find a decent $500k single-family home or duplex in a decent neighborhood that'll handle three grad students plus a renter or two plus assorted hangers-on and various camp followers is the most affordable neighborhoods of Central San Jose, and you'd be surprised at what you'll find there in that line. Some of it is amazingly crummy, much of it has been ridden hard and put away wet for the better part of a century, but some of it is amazingly compelling, and there's enough of the latter to tempt me to cash out and downsize to a nice 1920s bungalow in well-preserved original condition within easy walking distance of one of Silicon Valley's finest downtowns. (My wife may have something to say about this.)

The second reason we'll spotlight core Central San Jose is that the neighborhood is, as the chart above shows, hard hit by the subprime crisis. All the symptoms are there: a plentitude of short sales (sellers trying to convince lenders, usually unsuccessfully, to accept less than the loan balance); bank-owned homes, also called REOs (Real Estate Owned); bloated inventory; constipated sales; plunging prices; and a host of buzz-words and -phrases littering the MLS ("seller will carry!", "priced below comps!", "motivated seller wants offers!") that make the dreary trudge though Central San Jose listings a little like trailing the retreat of a badly defeated army.

But as I said, it's getting better. Just slightly better, but slightly better is always a step in the right direction. So much better, in fact, that I'm a little worried my grad students may be running out of buyer's market.

Sales, you'll note, are picking up.

Both sales of "short sale" and bank-owned (REO) properties have shot through the roof in recent months, although any sales upsurge would look dramatic against the backdrop of a Central San Jose market that's languished comatose for most of the past year. In April 2008 sales in the core downtown area finally broke out of the teens (and those were the good months), and June's whopping forty-four sales must have had local agents doing the conga down First Street. This outburst should be taken with a grain of salt, however, since eighteen of those forty-four June sales were short sales, and the jury is most certainly still out as to whether the typical short sale can and will cross the finish line and close escrow. Here's why I'm skeptical: in none of the past twelve months has short sale inventory been less than 9 percent of downtown San Jose inventory, and in recent months it's been a quarter to a third. That's seven-hundred seventy-four (774) short sale listings over the past year—yet only four have closed escrow.

So if a short sale in this neighborhood has a roughly 1-in-200 chance of closing, I'm wondering if the agents getting their clients in contract on these properties don't qualify as hopeless optimists. Especially when some of these short sales have been in escrow seven months. Somehow this reminds me of an endless Victorian lawsuit that ruins generation after generation.

More reassuring is the sharp rise in REO sales. Banks tend to be motivated sellers, at least when it's their name, not their borrowers', that's on title, although even here there are exceptions. It's interesting to watch the modus operandi of various lenders as they sell, or try to sell, or stumble and bumble their way through the motions of selling, properties in the Central San Jose marketplace.

For example, just today I spoke to an REO agent—twice—who did everything but throw furniture at me, yet last week I talked to another REO agent so helpful he did everything but write my offer for me. Most REO properties in Central San Jose are listed by a handful of niche market specialists and, as you might expect—although, frankly, I didn't—the level of presentation and professionalism varies widely. This is, after all, corporate America, disposing of assets worth half a million dollars, and supposedly accountable to shareholders, and it's not like the mortgage bankers have never done this before, but what I see is not always a smooth, well-oiled machine. It's not just that banks aren't paying for staging and latte carts. In many cases they've not paying for cleaning, or mowing the lawn, or clearing out the evicted homeowner's belongings, or making sure all the doors lock and all the toilets flush.

Some banks put their money in odd places. One REO listing has "winterized by Joe" stickers plastered all over the bathroom—some bean counter at World Headquarters three thousand miles away must think San Jose is frozen tundra (or more likely it's simply orders, orders that must be obeyed!)—and skimps on the commission it offers buyers' agents, while other banks with a firmer grasp of reality skimp on the winterizing and instead blandish larger-than-normal commissions and bonuses. The former shows a nice sense of priorities (and yes, I showed the property to my clients anyway) and it's no surprise that this carefully winterized listing expired without selling.

Have a listing that's not selling? If you're a bank, don't spend a few bucks giving it sorely-needed sparkle and zip. Mercy no. Just hand it to another REO specialist who'll do nothing more proactive than hang his own lockbox on the front door. As long as he fills in his weekly reports neatly and in triplicate, he's everything a bank could hope for in a listing agent.

After brooding thoughts like this, and after having yet another REO agent treat me like a nuisance (I'm not used to this, even when I deserve it) it struck me that dealing with bank-owned property is like dealing with the DMV. Then it struck me that this was a gross insult to the DMV. If you have an appointment, dealing with the DMV is pretty painless. No, friends, this is more of a cautionary tale, a foretaste of what home-buying would be like if Huge Heartless Financial Institution N.A., and not the independent contractor three doors down, sold real estate. The self-employed agent down the street may not be Albert Einstein, Donald Trump or Mother Theresa, but neither are the minor corporate functionaries you'd be dealing with if Big Banks got into real estate, and the neighborhood agent probably cares more about what you think.

And yet, I have to admit that the bureaucracy-from-hell approach to home selling isn't a whole lot different from the way a sizeable number of non-REO properties in the same price range and neighborhood are marketed. This is very much a no-frills (and even low-on-essentials) end of the market, and what the banks are doing rates maybe a good solid 2.7 on a scale of 1 to 10, at least by the standards of this price range.

Despite all the juicy talk about the mortgage crisis hitting affluent neighborhoods—the revenge of the envious—REOs and short sales are very much a phenomenon of the very lowest end of the price range. As the chart below shows, the average REO and short sale listing have much in common, and there's a substantial difference between them, on the one hand, and the average non-REO or non-short sale listing on the other, even in core downtown San Jose, an area remarkably homogeneous in the size and quality of its housing stock.

The axis on the left is average sales price, on the right average home size in square feet. While it's obvious that Central San Jose REOs sell for less—there's gold in them thar REOs!—it's also obvious that Central San Jose REOs are smaller, and smaller homes usually mean smaller lots and a more humble neighborhood, all of which means smaller sales price. Almost without exception, short sales and REOs make up the very bottom end of the Central San Jose housing stock, itself one of the most humble housing stocks in Silicon Valley. I suspect that this is true of most if not all neighborhoods hit by foreclosures, now and in the past, which may explain the idea that REOs are bargains.

And while we're on the subject, let's talk about the idea that banks give away their homes, and by doing so cause the value of every home to crash. From what I've seen, banks don't march in lockstep on pricing. Some price their listings above market value, either deliberately or from ignorance and good old seller wishful thinking, then gradually but methodically reduce the price. Others list their properties at what seem to be giveaway prices that are, in fact, simply the new floor for home prices. Banks don't set the new floor—buyers do—but banks are usually the first to find it. Banks rush in where Ma and Pa Homeseller fear to tread. It's my belief that, far from being bargains, REOs are often the only fairly priced homes on the market, and because of that, the ones most likely to sell. Note that it was mostly REO sales that kick-started the Central San Jose market this April.

Rebounding sales is one cause for optimism in Central San Jose and, by extension, other low-end marketplaces and, by extension, public perception of the entire real estate market. The other is a decrease in short sale inventory. The chart below shows that, for the first time in at least a year, Central San Jose short sale inventory declined in June.

Of course, REO inventory increased by almost the same amount, but this was inevitable—today's short sale is tomorrow's REO, no ifs, ands or buts—and a step forward by the tough-love standards of the marketplace. No, it's never good when people lose their homes, and seeing the mute reproaches to loose underwriting and cynical marketing, neglected vacant house after neglected vacant house, almost feeling the failed aspirations surrounding these homes, is enough to make you dislike that part of the mortgage banking industry (and that part of human nature) responsible for it. Being part of the clean-up crew isn't uplifting.

But the onrush of REOs seems the only way out of this mess: people who should never have been given loans were, and the sooner this system lapse and social catastrophe plays out the only way it can, the sooner we'll get through it. I hate to sound like a hard-hearted Treasury Secretary but, more and more, the hard way looks like the only way, not just to make the world a less scary place for the fence-sitting first-time home-buyer, but to make the world less scary for the average malaise-stricken American consumer.