This time:  worse, better, about the same, or all the above?

The other day I was discussing the last local real estate bust, in 2001, with a client and she asked, "Wouldn't you say it's much worse this time?"  Without hesitating I said, "No, I wouldn't.  It depends."

Whoa!  you may exclaim to yourself, as you think of headlines blaring record foreclosures, frozen credit markets and imploding financial markets, that sounds like a bad case of industry denial and self-serving boosterism.  But the downside to getting your knowledge solely from headlines—or from front-page news stories, or from back-page news stories, or from the press releases so many news stories are based on—is that you run the risk of acquiring a knowledge base a mile wide and an inch deep.  You run the risk of being remarkably ill-informed on a wide range of topics.  Not that you or I run this risk, of course, but, frankly, other people do.  What I'll say here may not give them, you or I the whole story either, but it's more than anyone will get from the headlines.

There's no doubt that home prices in most local neighborhoods have declined from their peaks, whether those peaks occurred in 2005, 2006, 2007 or 2008.  There's also no doubt that every low-end neighborhood around here has been hammered unmercifully by foreclosures since late 2007.  This Web site has a number of articles that document this, partly because I work in and write on a variety of local cities and price ranges but mostly because the catastrophe unfolding in this area's most affordable neighborhoods has for me the awesome fascination of a slow-motion train wreck.

When an article on the front page of the San Jose Mercury tells you that the median sales price of a Santa Clara County home declined 29 percent from September 2007, that's true, as far as it goes.  But it doesn't mean that every Santa Clara County home has lost 29 percent of its value.  And those record foreclosures don't necessarily mean "it's worse this time".  It certainly is worse this time—in certain neighborhoods.  In others, it's about the same.  In others, it's not as bad. 

This won't comfort the East Palo Alto or San Jose homeowners losing their homes, or those still hanging onto homes that have lost an eye-popping 30 or 35 percent in value over the past year.  But it may bring some cheer to—or at least check the incipient hysteria among—homeowners in less hard-hit neighborhoods who take their news literally and without a chaser.

To see how today's down market compares to "last time", the real estate market of the dot-com bust, let's look at representative cities or neighborhoods in Santa Clara and San Mateo counties, as well as a few "macro" markets that span both counties.  We'll measure the percent price change between the dot-com peak, Q4 2000, and its trough, Q4 2001, and compare it to the percentage change between Q3 2007 prices and the most recent closed quarter, Q3 2008. 

First we'll look at these Santa Clara County cities or neighborhoods, ranked top-to-bottom immediately below and on the chart from most expensive to most affordable:

You can see that last time the higher-priced neighborhoods were, for the most part, the hardest hit, while this time the reverse is true.  Why the difference?  Last time, a sudden injection of dot-com money abruptly pumped up prices in midrange and top-end neighborhoods, and its sudden withdrawal abruptly deflated same.  This time, a sudden injection of subprime lending abruptly pumped up prices in low-end neighborhoods, and its sudden withdrawal abruptly deflated same.  Put another way, last time, buyers loaded with dot-com bucks generally avoided low-end neighborhoods.  This time, buyers relying on subprime or other risky financing generally couldn't afford midrange or top-end neighborhoods...and as we're finding out, more than a few couldn't afford low-end neighborhoods either.

Something else is going on this time, something that in previous articles I've called "flight to quality".  Note that entry-level Palo Alto home prices have been essentially flat and, even more remarkable, what they don't show is something experience tells me:  the most desirable homes in this price range, in the most desirable neighborhoods, have gone up sharply in price.  How can that happen?  Around here Palo Alto is generally considered the gold standard for relatively affordable quality of life, and entry-level Palo Alto is the most affordable—although far from the easiest—way to get that lifestyle.  Palo Alto has a strong "brand", and that brand has held up well in this tough market.

Next, let's look at representative cities and neighborhoods in San Mateo County, again ranked by affordability:

Here it's much the same story, except note the night-and-day difference between the East Palo Alto/Belle Haven market's strong performance during the dot-com bust when, by the way, home prices there "had" to go down (sound familiar?) because they were going down in more expensive neighborhoods, and the beating it's taking this time.  And check out entry-level Menlo Park, similar both in price range and performance to entry-level Palo Alto, and for much the same reasons.

Finally, let's compare four "macro" markets that each take in a large number of similar neighborhoods in both counties:

All were Meccas for dot-commers and heavily affected by the dot-com boom and bust.  And so far, they've taken a minimal hit this time around.  Again, these neighborhoods were generally too pricey to attract buyers with risky financing, so haven't been hit by foreclosures.  And they're still highly sought-after, even though the dot-commers of 1999 have largely disappeared, been absorbed in the mainstream or wound up in museums.

Worse, better or about the same this time?  As with much else in real estate, it depends.

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