Attention first-time home buyers:  prices are now officially stupid cheap.

A few days ago a pest inspector was letting my first-time buyers know what his inspection had found in the home they were in contract to buy and, inevitably, they asked him, "Is the house worth the purchase price?" 

It'd sold in 2005 for $585,000, apparently with multiple offers.  Now it's listed at $275,000.  That's $275,000 USD for a single-family home with three bedrooms and two baths on a 5700 sq.ft. lot, nestled in a well-maintained block with a semblance of Norman Rockwell charm.  It's maybe thirty seconds from a large public park and a new branch library, and a minute or two from an appealing-in-a-funky-way neighborhood shopping district.  Although the home is a bit tired, as every central San Jose bank-owned home is, it has a newer kitchen, windows, roof, furnace, AC and upgraded wiring.

"Is it worth $275,000?", asked the inspector rhetorically.  "Heck yes, it's worth $275,000."

He's a veteran I've used for years who doesn't normally get demonstrative about a house, let alone a house as modest as this one, and that's when it hit me:  Homes at the low end of the market aren't just really really affordable these days, no, they're officially stupid cheap.  Starter homes in starter neighborhoods are now on Blue Light Special.  Call it a Kmart market.

Consider these home sales, in the same central San Jose neighborhood as that $275,000 house, that have closed since 12/1/08:

Okay, I'll admit the last one's a ringer, although that $1.16M house selling for 36 percent more in 2008 than it did in 2003 (without any apparent upgrading to account for the premium) wasn't far from all those houses selling at 30 or 40 percent discounts to their previous sales prices.  But the $1.160M house is in a neighborhood called Rose Garden that wasn't pumped up by subprime lending during the tail end of the boom, and hasn't been hit nearly as hard by foreclosures during the bust.

This difference in the performance of the two price ranges is startling, so let's examine it more closely.  First we'll look at Palo Alto, one of those mid-Peninsula real estate markets where "starter homes" start at $1,000,000.  Here's Palo Alto closed sales since December 1 that had previously sold within the past nine years:

Even more startling is that 62 percent of the thirteen central San Jose houses sold and closed since December 1 had previously sold from 2004 to 2006, when subprime lending and 100 percent financing boomed, while none of the Palo Alto homes did.  That's not a coincidence.  While prices have slipped recently even in sought-after top-end cities like Palo Alto, the real damage has occurred in the ultra-affordable neighborhoods.  Why?  Because bank-owned homes virtually don't exist in affluent neighborhoods.  Why not?  Because subprime and 100 percent financing was never a factor in those neighborhoods.

So while central San Jose, and neighborhoods like it, are now officially stupid cheap, Palo Alto and cities like it aren't.  And aren't likely to be.

So it's good news-bad news for first-time buyers:  yes, it's a great time to buy a starter home, especially if you're the kind of person so often priced out of local real estate during the boom—a normal person making a normal salary—but the neighborhoods traditionally sought after by affluent buyers are still unaffordable.

But there's still plenty of good news for low-end buyers, and it's that money is also officially stupid cheap. 

And, contrary to what you've heard, stupid cheap money is plentiful if you have good credit.  30-year fixed-rate conforming loans (those under $417,000) are widely available at rates of around 5 percent or less to buyers with credit scores of 720 or above.  Yes, it'll take you longer to get pre-approved than it would have back in July 2007, and longer to get your loan through the once-again rigorous underwriting process.  Yes, lenders are back to requiring that you either put down at least 20 percent or buy mortgage insurance with 10 percent down, but the FHA loans, which offer federally-guaranteed mortgage insurance, require as little as 3.5 percent down.

So let's see what all these numbers mean in plain English.  My buyers are ready to lock on a 30-year fixed-rate loan from a major lender at 4.875%.  If they put 20 percent down on that $275,000 house, their mortgage payments will be about $1160 a month.  The home would probably rent for about $1600 a month.  Of course, my buyers will have additional homeownership expenses:  property taxes of about $286 a month; insurance of about $100 a month; and maintenance expenses.  But they can deduct the interest portion of their mortgage payment, which will be almost the entire amount of their payment in the first years of the loan.  And they can deduct their property taxes.

Of course, my buyers face the prospect that home prices may continue to go down.  But that's the prospect that makes today's real estate market a buyer's market—and "buyer's market" means "a market that favors buyers".  And it's that same uncertainty that, paradoxically, makes today a far better time to buy than back in the glory days when prices were going up like a rocket and everyone was convinced that real estate was a sure-fire investment. 

Back then it was easy to get psyched up about buying a house, and hard to buy one.  That's a seller's market.  Today it's hard to get psyched and far easier to buy.  That's a buyer's market.

Today the "smart" buyers are out of the market and on the sidelines, waiting for the flashing neon light (or article on Yahoo! Real Estate) that tells them "It's officially safe now.  There's no more uncertainty in the market.  You have permission to buy a home".  That's what every "smart" buyer is waiting for.  But what "smart" buyers don't get is that lots of buyers—in fact, most buyers—are waiting for permission to buy.  And when lots of buyers—in fact, most buyers—jump into the real estate market at the same time, what was a buyer's market turns into a seller's market.

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