Answering today's top three real estate questions.
The three questions most frequently-asked of real estate agents these days are:
1. Are prices coming down?
2. What do you see happening in 2008?
3. Has my home lost value?
The short answers to these questions are:
1. It depends.
2. Beats the heck out of me.
3. It depends.
Next week we'll address another question on everyone's lips these days, "What is the meaning of life?".
The answer or answers will be the same.
Thank you, and good night.
What's that? You'd like more detail? Okay, here goes.
Question 1: Are prices going down?
Yes and no. It depends on where you live.
If you live where most buyers have had to over-extend themselves to buy a home over the past few years, the answer is most likely "yes".
But when I say "over-extend", I don't mean the bubblehead definition of an over-extended homeowner, which is anyone who puts a crimp in his or her lifestyle to pay the mortgage. That is, or at least was until the Internet popularized entitlement as a homebuying strategy, the traditional definition of a homeowner. So no, by "over-extended" I don't mean homeowners who went beyond merely sacrificing part of the effluvia of modern life—buying new cars, taking dream vacations, eating out every night, collecting the latest gadgets that next year will cost half what they sell for this year—to achieve a meaningful goal. By "over-extended" I do mean homeowners who went beyond sacrificing the bells and whistles of consumerism and sacrificed everything to achieve an unachievable goal.
Could I be a little more specific?
Yes. In fact, I'll crunch and graph some numbers.
In fact, to show how divergent the real estate market is these days, I'll compare and contrast three pairs of sub-markets in four local cities. Four of these sub-markets are in two cities, San Mateo and Sunnyvale. In the case of Sunnyvale, I'll compare entry-level North Sunnyvale near 101 to the pricier neighborhoods near 280 with sought-after Cupertino schools. For San Mateo, I'll compare the entry-level neighborhoods of Shoreview and Parkside east of 101 with what might be called the Big Four of top-end San Mateo: San Mateo Park, Baywood, Aragon and Baywood Knolls. The final two sub-markets are in adjacent cities: ultra-affordable East Palo Alto and the move-up neighborhoods of south Palo Alto. It's important to note that none of these three pairs of sub-markets are more than fifteen minutes from each other by car. East Palo Alto and parts of south Palo Alto even share the same zip code.
I've chosen these six sub-markets for two reasons. First, they give us a good representation of the local market, the neighborhoods of the mid-Peninsula and South Bay that make up Silicon Valley. San Mateo is near its northern end, Sunnyvale its southern end, while Palo Alto is Silicon Valley's geographical and intellectual nucleus. The fourth city, East Palo Alto, is part of Silicon Valley geographically, yet in many ways its market more resembles the rest of California.
My second reason for choosing these cities is that I'm familiar with their sub-markets. This may sound quaint, now that the Internet has turned legions of bubbleheads and other spectators into leading authorities on real estate. Whatever wisdom I pass along here can't hope to equal the "collective wisdom" of people kicking tires at the occasional open house. Nor can I be as "objective" as those smokin' postings on the blogs, postings that would go unread if they were objective.
And guess what? The bubbleheads were right! Markets really do have cycles! But as an advancement of the banner of Science, this discovery ranks right up there with proving that the sun rises and sets. The real question isn't whether markets go up and down. As we'll see in a moment, the real question is three far more challenging questions: "when?", "where?" and "by how much?". "Soon", "everywhere" and "a whole lot" are easy feel-good answers for anyone who's bet that home prices will go down, but they lack scientific rigor. Besides, easy answers cost you when you take them to the bank. As Exhibit A I present America's Number 1 Bubble Blogger, the guy who tells you "it's simple". The guy who in 2000 decided to hunker down until prices went down. The guy who since 2000 has been renting in a Menlo Park neighborhood where, since he began blogging in 2003, prices have gone up every year. The guy who should be saying, "Take it from me, it's anything but simple".
Now that I've taken my obligatory swipe at the bubbleheads, let's get to those questions.
Question 1: Are prices going down?
Let's take a look.
Prices have dipped in each of the low-end neighborhoods we're comparing while soaring in each move-up neighborhood. And I suspect that this chart understates the cumulative effect 2007's declines had on low-end neighborhood prices by the end of the year. For example, the chart shows a six per cent decline in East Palo Alto home prices in 2007, yet a check of late-year closed sales suggests that the damage is probably twice that by now.
So the answer to question 1 really is, "it depends".
Question 2: What do you see happening in 2008?
Google "when will the housing market improve?" and you'll get about 707,000 results. No, I didn't read all of them, but I can safely tell you that they range from "the market is already improving" to "never", depending to some extent on whether your focus is home selling or bubble blogging. The answer also depends on the strength of your local economy: is it a booming Silicon Valley, a depressed Rust Belt or a Central Valley where new home prices outstripped the jobs necessary to sustain them? And bear in mind that, as we've seen, prices in many local sub-markets (and in some regional markets across the country) never did decline.
I can tell you that the National Association of Home Builders foresees a bleak 2008. That's significant in places like Modesto, where builders are still building acres of $450k homes, even though buyers for them are few and far between. That's not significant here in Silicon Valley, where new construction is usually one-off $3M "spec homes" sprinkled randomly through upscale neighborhoods. Different builders, different buyers, different markets.
I could also tell you that the National Association of Realtors® has an equally gloomy forecast for 2008 (to its credit) but national trends don't always apply to one of the most affluent and built-out local markets in the country.
Despite the multitude of answers, relevant or not, informed or otherwise, no one knows the answer to the real question: "when will things get better in the many depressed markets" locally and elsewhere. That's partly because we're in uncharted waters. The housing market has never declined when the national economy was solid; in fact, the housing slowdown and related credit crunch are taking down what was until recently a decent economy. And the housing market has never declined when interest rates were this low. The other part of the reason we're in the dark is that, as Brother Bernanke just publicly admitted, economists don't have much success predicting market turning points, even when they're working with the normal conditions they studied in grad school.
And if you live in Silicon Valley, there's yet another complication: we have two markets, each, as we've seen, performing quite differently.
And each of these two markets is independent of, and unaffected by, the other. Don't believe it? Think it's only reasonable that if low-end prices go down, top-end prices should go down with them? "It's simple", right? It would be, if top-end buyers cross-shopped low-end markets, but I've never run across or heard of one who does. The "bundle of benefits" that low-end and top-end neighborhoods each offer don't have enough area of intersection to attract the same buyers.
So the question for Silicon Valley real estate in 2008 is really two-fold: what might stabilize sub-markets now declining, and what might destabilize sub-markets now high-flying?
Sales, you're thinking. That'll do it. I know sales were way down this year. If sales go down, that means prices will have to go down too, and in every neighborhood, not just a few, and if not this year, then in 2008.
Let's look at sales first, but since that's too "simple", let's look at the whole picture as well. It's true that sales were down substantially in every local market I'm aware of. Here's the difference in sales in our six sub-markets between 2005 and 2007:
Sales were down significantly in every sub-market, and down catastrophically in several. But will lower sales mean lower prices? It depends. On what? On inventory. Here's where it gets interesting. Here's where it confounds the bubbleheads and other market-timers:
Note that inventory was up in two of the three entry-level sub-markets between 2005 and 2007. In the third, inventory was identical, but that's an anomaly. For a much more typical view of what's happened in entry-level neighborhoods this year, check out East San Jose where, for example, inventory ballooned from 548 homes to 895 between October 2006 and October 2007.
On the other hand, you'll notice that inventory was down sharply in all three top-end neighborhoods. In fact, top-end inventory shrank even faster than top-end sales.
Add up all this data and here's everything you need to know about these six sub-markets:
What you see above is the "absorption rate" for all six sub-markets. Think of the absorption rate as the "success rate" for sellers: it's the ratio of sales to inventory during a certain period, in this case one calendar year. The higher a market's absorption rate, the hotter that market is and the more it favors sellers. A declining absorption rate, on the other hand, indicates that a market is cooling and tilting toward buyers.
Whether you're a buyer or a seller, all you really need to know about a sub-market is its absorption rate. Nothing else matters. High absorption means there's competition for homes. Competition for homes means home prices will stay strong for the foreseeable future (which in real estate is about fifteen minutes). Low absorption means prices are falling and will continue to fall for the foreseeable future (see definition of foreseeable future, above).
But one thing seems plain, or as plain as real estate markets ever get. The real estate sub-markets now affected by the downturn won't recover until the bad loans and resulting "REOs" and "short sales" work themselves through the system.
You may have heard these two terms. An REO is a property taken back through foreclosure and offered for sale by the lender. A short sale is a property for sale with a loan balance higher than its market value. And from what you've heard in the media, you may be thinking that REOs and short sales stalk every neighborhood.
Let's verify this by comparing the number of total homes currently for sale with the number of REOs and short sales currently for sale in each sub-market.
Of the 131 homes on the market in East Palo Alto on December 19, 2007, 39 or 30 per cent are either REOs or short sales. Things are slightly worse in North Sunnyvale (34 per cent) and slightly better in Shoreview/Parkside (27 per cent).
In the pricier neighborhoods, the picture is quite different. None of South Palo Alto's 6 (yes, just 6) homes on the market are either REOs or short sales. I did see an REO on the market there earlier this year, out of the 192 homes sold in 2007. In top-end San Mateo there's just one listing on the market, but I won't count it because it's really a duplex, and it's neither REO nor short sale. (Maybe you're beginning to understand just how tight inventory is in these sub-markets.) In the interests of full disclosure, there was one short sale in top-end San Mateo just recently, a gutted house, obviously the work of a flipper gone belly up, that sold quickly, almost certainly to another flipper with deeper pockets. (No one else would buy a house that far from habitability.) One short sale, quickly absorbed, while 99.999 per cent of everyone looking for a home in top-end San Mateo is still looking.
Finally, one of the 6 homes on the market in Sunnyvale with Cupertino schools is a short sale as this is written in late December. That surprised me a little, and maybe more than a little, so I checked all sales in that sub-market from October 1 to present and found that none of those 17 were either REOs or short sales. But that short sale bears examining, because it represents something I allude to in another article: not every REO or short sale these days is in a low-end neighborhood. A few are appearing in price ranges one or two levels above, and this Sunnyvale short sale is a good example: priced above North Sunnyvale, but at the very low end of the Sunnyvale-with-Cupertino-schools price range because of its small size, contemporary architecture and location on a busy street. It's easy to assume that someone of relatively modest means got a relatively modest toehold in a sought-after neighborhood, then slipped and fell. Whether that's the case or not, I've seen the same thing in San Mateo neighborhoods west of 101 but east of El Camino and even, to a certain extent, west of El Camino. They've been in the price range—under $900k—of this Sunnyvale short sale.
So is this a ray of hope to the bubbleheads, whose demographics suggest they're more interested in top-end sub-markets than low-end, and to all the other real or self-styled market timers out there? After all, one of the mantras of the blogs is that "even doctors and lawyers get over-extended" (although I suspect that the typical Silicon Valley doctor struggling to afford a home would find this ironic. Maybe we should change it to "even VCs and lawyers").
Sure, even professionals (and let's not forget the successful tradespeople who buy in more affluent neighborhoods) get in over their heads. But remember, these are homebuyers with far bigger safety nets and far less need for the subprime financing, "exploding ARMs" and "liar loans" now getting other homebuyers in trouble. And the Silicon Valley economy is still good, at least for them. And their home values are still going up, not down, so refinancing is still an option. So what's the chance of foreclosure hitting these top-end neighborhoods just as hard as it's hit the low end? Not great, based on the early returns, and they're not that early anymore: we're well into the carnage in low-end neighborhoods.
But those who've waited for prices to go down since 2000 or 2003 or 2005 (or 1995) are blessed with infinite patience, and waiting another year or five is certainly in the cards. For the rest, those who'd like to get on with their lives, waiting may be less attractive as an option.
How smart is it to buy a home now in a low-end neighborhood, either to live in or to invest? I think that investors and, to a much smaller extent, gentrification, are very much in the cards. By gentrification, I don't mean that people who'd normally buy in, say, San Mateo Park are going to be buying in Shoreview. I do mean that many of the people who until recently were buying in Shoreview are right back where they were five or ten years ago: locked out of the mortgage market. That's unfortunate because, lost in all the "mortgage mess" hoopla is the fact that the majority of buyers who snuck into homeownership when corporate greed opened the door wider than normal are still homeowners.
But it's my guess that anyone who buys in hard-hit neighborhoods should be willing to accept at least another year of declining prices. The 30 or 35 per cent of current listings that are REOs and short sales in these neighborhoods doesn't include all the listings that use some variation on "extremely motivated seller". It doesn't take much to guess that many if not most of these "extremely motivated sellers" are tomorrow's short sales and, if the way lenders have handled short sales so far is any indication, the next day's REOs. On the other hand, I think it's foolish to wait until these markets have absolutely positively bottomed out, because the only way we know we've hit bottom is when prices are on their way back up. Astute buyers don't wait for the market to get even worse before they buy. I see buying opportunities in these neighborhoods that I haven't seen in years, and maybe never. "Cherry pick the best and leave the rest" is undeniably opportunistic, but it's what smart buyers have done in declining markets of all kinds, most likely since the invention of markets.
What will it take to take down the top-end neighborhoods? More inventory. Tight inventory has been the biggest challenge to buyers in every hot market I've known since 1998. Why aren't more top-end homeowners putting their homes on the market? The answer is complex and largely unknown, but I suspect it has to do with Prop 13, a capital gains tax exclusion of "only" $250k or $500K (not much for a long-time Silicon Valley homeowner) and, ironically, the fact that there's little top-end inventory, which gives affluent or equity-rich move-up buyers few options.
What'll it take to shake loose more inventory from the top end? I could be wrong, but I wouldn't depend on foreclosures. What's worked in the past is a good old-fashioned tech bust, but we seem far removed from the days of an overheated tech economy and overheated market valuations. A national recession might do it but, as 2001 proved, Silicon Valley's fortunes don't necessarily track those of California, let alone the nation.
Question 3: Has my home lost value?
There's an obvious short answer to this question: "it depends", or "see Question 1, above".
Then there's a second set of short answers: Do you live in a move-up neighborhood? Or put another way, do you live in a neighborhood where most homeowners have a few years of homeownership under their belts before they buy? Does your neighborhood look like most neighborhoods but sell for a little or a lot more than most neighborhoods?
If you've answered "yes" to any of these, then most likely your home's value was stable or even increased in 2007. Because, most likely, your neighborhood is more than just a street with houses on it. Your neighborhood offers the tangible and often intangible benefits that people will pay a little extra or a lot extra for. That's the kind of neighborhood that did okay or better in 2007.