2015 was a tale of two years. The year started off tremendously well with a surge of prices and activity very early in the spring. Not surprisingly, given its recent performance, the Palo Alto market was particularly strong. From March 2014 to March 2015, the price per square foot for Palo Alto shot up by 29.55 percent.
However, as the year progressed, we saw a gradual yet distinct slowdown in sales and appreciation, which was particularly noteworthy in some of the areas that experienced the strongest gains over the last three years. The reason for this slowdown can be attributed to the following three factors: (1) the price differentials between the most sought-after Silicon Valley neighborhoods and other alternatives, (2) the turmoil in the Asian stock market and the devaluation of the Chinese currency, and (3) general concerns about the likelihood of future appreciation, especially in light of more anticipated mortgage rate increases.
(1) The Price Differentials Between the Most Sought-After Silicon Valley Neighborhoods and Other Alternatives
Over the course of the past three years, we saw remarkable appreciation in Silicon Valley real estate prices. For example, between October 2012 and October 2015, Palo Alto median sales prices rose 49.76 percent, and the price per square foot rose 53.76 percent. While this certainly was tremendously beneficial to homeowners in prime parts of the Peninsula, it also resulted in price disparities that were far more than the historical norms. For example, Palo Alto and Los Altos home prices have long been more expensive than those of surrounding communities like San Jose, Santa Clara, and Redwood City. However, in 2015, the delta between comparable homes in Palo Alto and in San Jose was roughly double historical norms. As a result, more and more buyers began to consider the possibility of living outside of the traditionally sought-after neighborhoods at the core of the Peninsula.
As recently as three years ago, buyers tended to focus on particular cities that interested them, but we have noted that more buyers are beginning their home searches with a more open mind. Oftentimes, they now ask to extensively tour other communities to understand the price differentials between Palo Alto and outlying areas. While many of these buyers still long to live in places like Palo Alto and Los Altos, economic realities compel the consideration of other alternatives.
As a result, we expect to see a relative flattening of Palo Alto prices, especially when compared to outlying communities that haven’t fully rebounded from their 2008 lows.
(2) The Asian Stock Market Turmoil and the Chinese Currency Devaluation
The Asian stock markets, most notably in China, have been on an exhilarating, albeit scary roller-coaster ride over the past couple of years. By way of example, the Shanghai Stock Exchange Composite Index was at 2,083 on January 3, 2014, soared to 5,166 by June 12, 2015, and rapidly descended to 3,052 by September 28, 2015. Although it has since recovered to 3,579 as of December 18, 2015, many riders are feeling a bit nauseated. Despite the net increase of over 50 percent in less than two years, many people are focused on the huge drop from its heights. The significant drop in China’s stock market in July 2015 led to concerns that Silicon Valley’s real estate market would subsequently suffer.
The impact of the instability in China resulted in a bifurcated market. Homes valued at over $5 million still received a lot of attention from affluent Chinese buyers, whereas there was a decrease in interest from Chinese buyers for homes valued at less than $2 million. Casual discussions with many Chinese buyers revealed that the merely-rich in China were reluctant to buy properties overseas after seeing a material drop in their net worth. On the other hand, the uberrich’s increased desire for diversification as a result of the perceived instability actually increased their demand for higher-priced properties.
However, the recent slowdown in the local real estate market seems to have gone far beyond the actual slowdown from Chinese buyers. The mere concern that foreign buyers were going to stop buying caused many other buyers to put aside their purchasing plans. In other words, the fear of a market correction began to induce an actual market correction.
Looking back, we believe this concern was exaggerated in the minds of many buyers. Typically, the local real estate market is relatively slow to respond to global events, and there is often a tendency to overreact. The Asian stock market has started to rebound from where it was in July, and Asian buyers are returning to the market at all price-points. Nevertheless, many real estate agents and buyers still retain their concerns. We expect that the local real estate market will reenergize over the next few months as it begins to realize that these concerns were exaggerated.
(3) General Concerns About the Likelihood of Future Appreciation Despite the fact that Silicon Valley’s economy has been doing quite well, many couples with strong incomes still find prices unaffordable. As a result, there has been a shift in market dynamics, and some buyers have begun to consider long-term rentals rather than aspiring to own. In 2015, we saw this trend continue to intensify. This trend also was consistent with the mindsets of many young professionals who enjoy the flexibility of moving without worrying about selling their homes or incurring additional transaction costs. On December 16, Federal Reserve Chairperson Janet Yellen announced a long-anticipated 25 basis point increase to the Federal Funds Rate. This was the first increase in almost a decade and it raised the Fed’s benchmark interest rate from near zero, where it hovered for the past seven years. Perhaps more importantly, Ms. Yellen expressed an expectation of an additional one percent increase over the coming year. While the broader market saw this move as a sign of a strengthening economy, the actual impact on monthly mortgage payments may have a cooling effect for some home purchasers.
Although there is certainly concern in the marketplace, we expect to see relative stability because many homeowners are reluctant to sell due to onerous capital gains taxes they would have to pay (see “Tax Concerns Contribute to Housing Inventory Shortage,” The DeLeon Insight, May 2015). Additionally, many foreign buyers tend to hold properties for longer periods of time. The combination of these two factors should continue to result in a relatively low inventory going forward. Any economist will tell you the relatively low supply and the high demand for homes in this prime part of the country should create an environment of stability, despite the abovementioned bumps in the road.