The Mirage of Palo Alto’s Falling Home Prices

March 3, 2023

These are trying times for homeowners in Palo Alto looking to sell. Metrics all seem to indicate that the sky is falling. Headlines proclaim the apocalypse to be nigh. And buyers are eager to pounce on the hapless reeling seller with bargain-hunting lowball offers. There was a “Shift” in the housing market midway thru 2022, and residential real estate is crashing. Anyone can see it, right?

There is some truth to this narrative of Palo Alto’s housing price decline… but as we shall see, most of the decline is a mirage.

The arguments that a housing crash is upon us boil down to a few observations. First, sales prices and dollars per square foot are falling month on month (“The numbers don’t lie”, some will say). Secondly, declines in list price are the norm now (“Every alert in my inbox is for a price reduction!” realtors claim, with some truth). And thirdly, macroeconomic forces are getting worse: geopolitical tensions are high, interest rates are rising, stock markets are crashing, political dysfunction is a serious risk, and the recession probability is rising—all of which will crater house prices, so it is said. Thus, due to these three “irrefutable truths”, buyer agents are confidently spamming out lowball offers of 20% below list price, because they figure they can. The Shift changed everything.

We’ll look at these three arguments, assess their strengths, and then dive in to the drivers of this decline, and why it is not all it seems. Hang tight, Palo Altan Home Owner. It’s not nearly so bad.

Methodology Note

All data in this analysis comes from MLS transactions and excludes “off-market” sales which are rare and don’t affect the narrative much (375 transactions closed in 2022 on the MLS versus 383 in the County records; the median sales price is only $20,000 apart). All dates below refer to Sale dates, not Close dates.

One data point is omitted from most of these charts, the rather spectacular 1934 Waverley, which sold on July 6, 2022 for $28.5 million. It was the largest sale of the year in Palo Alto, but is such an outlier that it makes the rest of the charts hard to read. It *is* included in all average or median calculations.

The Decline in Price

Let’s look at these three arguments one by one. Take the decline in sales prices and dollars per square feet first:

Above are two views of the same thing: sales prices in Palo Alto in 2022. The first shows each one of the 354 individual sales. The second is the same data, showing the median sales price for each month. Both lines are going down fast.

(By the way, notice the visual trick we employed on the second image above: by starting the Y-axis at 800 instead of zero, the downturn looks more exaggerated. Two charts below we do not manipulate the axis. Beware the data analyst with an agenda! OK no more tomfoolery :-) )

Closely related are charts showing the decline in dollars per square foot:

We realtors typically prefer “median $/sf” over “median sales price” because it equalizes between houses of different sizes. Or at least it “kinda sorta” does. The metric works well when we are comparing things of the same general quality level—for example, a comps analysis where all properties are similar in price, geography, age, and features. But this metric can fail when comparing things of significantly different quality. We’ll talk more about this soon.

List Price: Sellers Seem in Retreat

Let’s look at the discrepancy between list price and sale price. Did sellers have to offer a price concession to move the property in 2022? If so then momentum is shifting to the buyers, right?

The “% over list price” metric is unquestionably on a downward trend, and more negative than positive lately.

But does that mean that the list price was ever set correctly? Or that list price is some reflection of truth? Not at all! “List Price” is a marketing tactic, not some true value of worth. During the COVID boom years, many sellers would settle on a list price by saying, “let’s take the rational analysis determined by a thoughtful comps analysis and juice it up by 15%, because the market is going up and this data is old” So an increased number of price reductions *is* a reflection of seller expectations being knocked down. But it is not necessarily evidence that any particular house should have to cut price by 10%.

Macroeconomic Malaise

The third argument is tougher to dismiss... because the signals are sometimes ambiguous and no one can predict the future.

Macro Worry 1: Geopolitical Tensions

The headlines today are nerve-wracking: Russia about to commence a spring offensive, China and the West de-globalizing, climate change. Perhaps we are at the end of the good times that underpinned our rising wealth over the past decades. But none of this is clear, and how it impacts home prices is also unclear. We just made it through a once-in-several-generations pandemic, and house prices… soared.

Macro Worry 2: Rising Interest Rates

The Fed *has* raised the Fed Funds rate (the rate at which banks lend to each other) 8 times since March 2022 (from roughly 0.25% to 4.5%), all in an effort to tame inflation. The Fed Funds Rate has a loose correlation to the 10-year T-bill, which is what mortgage rates are typically tethered to. Rising rates (from roughly 3% for a 30-year fixed mortgage at the start of 2022 to ~6.5% in February 2023) absolutely do depress buyers’ ability to afford homes. But it also reduces inventory, as sellers decide to stay put rather than exchange their cheap mortgage for a pricey one. So fewer buyers compete for less inventory… its not obvious which side this trend favors more. As a realtor, the velocity of the market has gone way down, which impacts the health of our business to some degree, but that is not a problem for a seller today.

Besides, today’s rates are not terribly high versus history. They are only high measured relative to the past few years.

Macro Worry 3: Stumbling Stock Market

When the Fed started raising rates in mid 2022, stock markets went into freefall as the odds of recession were thought to be high. But are current stock prices so awful?

The chart above shows that markets (if you accept that the Dow Jones Industrial Average is a representative metric) have recovered to pretty much to where they were before the Shift.

However we in the heart of Silicon Valley are more affected by stocks like Facebook (Meta), Google (Alphabet), and Apple, right? Will they show more exaggerated downturns?

Hmm. Apple doesn’t look so bad in context…

And Google is down, but only to 2021 levels. What about Facebook?

Well, okay, Facebook has not been a great stock lately. But even its stock has doubled since the worse day of the Shift-induced stock decline.

The point here is that neither the broader market nor our local stock titans are enjoying inevitable growth, but neither are they falling into the abyss. If falling stock prices were the reason for a lack of buyers, we should have felt that in late 2021… but buyers were going gangbusters back then.

Macro Worry 4: Politics

Political dysfunction is a big risk. If America defaults on its sovereign debt, as we seem to not mind our leaders flirting with, all Americans get poorer as borrowing costs rise and the dollar buys less internationally. But America is huge and economically vibrant; its not obvious that such a future harms Palo Alto home prices. And you know what were other political risks? Our response to the pandemic. Or the previous administration’s punishing of Californians with changes to the deductibility of SALT taxes. Such shocks can be expected to keep coming, and impact us randomly. Some will be good, some will be bad, but they are largely unknown.

Macro Worry 5: Recession Risk

A recession, typically defined as two quarters of negative economic growth as determined by the NBER (but actually a judgement call by these folks) may happen, but its complex. If we are in recession, it’s a historically unusual one: household wealth is high and unemployment is low. If declared, a recession is widely anticipated to be mild and short. But it could indeed happen. Or it might not.

The Drivers of the Slowdown

So, dear reader, we have muted the arguments of the doomsayers. But to really counter them, we’ll need to consider context, and understand the drivers of the falling median sales price and dollars per square foot calculations.

The first thing to note is the slowing velocity of the market in general. Look at how days on market is tightly clustered in the first half of 2022, and all spread out in the second half (higher dots took longer to sell):

Everything just took a lot longer in the second half. Anecdotally, realtors active in Palo Alto felt that good houses were still selling, but houses that had anything wrong with them (an aggressively high price, work needing to be done, sloppy prep work or weak marketing) were languishing. But we also felt that there was a lack of “nice” inventory. How can we quantify this? Was something really going on with the mix of houses that were being sold?

Housing Mix: Lack of Inventory in Prestigious Areas

Let’s consider neighborhood mix first. The most prestigious Palo Alto neighborhoods are considered by many to be Old Palo Alto, Crescent Park, Community Center, and Professorville. These areas were settled earlier, have superior construction quality and aesthetics, and are updated more frequently than other areas of the City. And people often want to be close—but not too close—to the vibrant downtown areas on University Avenue and California Avenue. So let’s compare all the sales of 2022 with the “prestigious” neighborhoods in orange, and all other neighborhoods (i.e. – downtown itself, Green Gables, and South Palo Alto) in blue:

In the first chart, we see a lot of orange dots in the first half and few in the second half, whereas the blue dots continue on at almost the same pace as before the Shift. In the second chart, we see the cumulative listings of Other in blue, which bends down slightly during the year, and Prestigious in orange, which notably curves down. The numbers by the lines are the new sales in that month.

If we go bottoms-up and compare the two, there were 59 sales in the Prestigious areas in the first half of the year, which fell to 30 after the Shift – a drop of 49%! By contrast, the other areas of Palo Alto only dropped 24%.

Said another way, the most prestigious neighborhoods used to make up 29% of sales, but after the Shift they were only 21% of all Palo Alto sales.

Because the Prestigious neighborhood prices and $/sf are higher, when the mix changes, the median $/sf and median sales price of the entire City drops. It’s not that any house necessarily declined in value, but the inputs to the median function changed in character.

Housing Mix: Where Did All the New Homes Go?

A second way to show that the mix of houses in Palo Alto changed throughout 2022 is to look at the age of the homes that sold:

This chart shows the percentage of all sales volume in that month. Absolute sales volumes were higher in certain months of 2022, but the thing to pay attention to is the ratio of the colors. The color shows the age of the individual houses that sold: yellow indicates new houses, black and grey indicate older homes. The year of construction is in many of the boxes above. Look at the way the newer, yellowish homes just decline as a fraction of the whole during the year. It is not a 1:1 correlation that “newer equals better”, but most buyers prefer new if given the abstract choice. Again in this view, the mix of houses changed pre- and post-Shift.

Housing Mix: The Incredible Shrinking Home

A third way to show that the mix changed is to look at the size of home. Is it the case that the second half of 2022 featured smaller (and therefore lower-priced) homes?

Yes, the data does show house size is declining in the Prestigious areas, while holding more steady in the Other parts of Palo Alto. The numbers below the dots are first, the median square footage of houses sold in that Area in that month, and below that, the number of sales in that month.

Smaller houses are not necessarily lower in dollars per square foot, but they are lower in sales price generally, as the chart below shows.

Housing Mix: In The Eye of the Beholder

But there is more: if we compare the specific houses in the first and second halves of 2022, realtors who go on tour every week can tell you that something else changed: the subjective beauty of the inventory.

Houses like 330 Coleridge or 925 Forest or 1317 Martin or 70 Waverley Oaks were beautiful in their own ways. Where are houses like that in the second half? Just not there. Instead, the houses in the Prestigious neighborhoods that sold were on streets like Alma, a busy throroughfare with little charm.

The Housing Mix Changed in Palo Alto

So we have four arguments why metrics like dollar per square foot and median sales price should decline in Palo Alto over the course of 2022. The mix of what sold shifted to less desirable neighborhoods, became older, smaller, and less beautiful.

It is not the case that any given house lost value by 15-20%. But it is true that Palo Alto’s metrics declined by that much. And the way to reconcile these seemingly contradictory statements is to note that the mix of houses sold changed. Throughout the year, driven by the Shift, we saw a higher fraction of smaller, older houses in less attractive areas, and fewer lovely houses on the market.

This May All Be Academic

If you don’t need to sell in a given year, then current home prices don’t affect you. Only sales prices at the time you actually want to sell matter. If you are happily raising your 10-year-old kids in a 4 bedroom house in Midtown and do not intend to move until your kids go off to college, then you have 8 more years of ignoring today’s market. Most years are good years for Palo Alto real estate. And, if in 2030 the market is soft, then you can just hang on for a year or two until the market recovers so that you can retire to backpack the globe. Refusing to sell into a weaker market is generally what we are seeing today, in fact. So unless you actually want to sell now, today’s home prices are academic.

Take a look at Palo Alto median sales prices over the past 20 years:

Pretty reassuring, right?

And If You Are Selling Into This Market?

Sometimes waiting for a better market is not an option. Life events like births, deaths, marriages, divorces, and job opportunities on the other side of the world continue to happen. So what should you do if you really need to sell into a market that is tougher now for sellers than it was a year ago?

First off, get yourself a good realtor (or some great ones :-) ). In tougher times, experience and intelligence matters more. Exotic contractual situations are more common. More creative financing gets employed more often. Cut-rate door-opener kind of agents don’t know how to win if things are not cookie-cutter. You want a full-service professional. The more insightful, persuasive, and energetic your agent is, the more likely that arguments like the analysis presented here will be in the minds of the buyers and their agents.

Secondly, remove all risks from the potential buyers. Refinish the floors; you reap twice the return in the increased purchase price relative to your costs. Cut down that giant tree that prevents developers from making offers, if you really do have the blessing of Urban Forestry. Make the property easy to show; don’t live there and require appointments. A well-prepped home sells for much more than the time and cost to get it ready (case study 1 and case study 2), especially for prep-work that removes uncertainty from the buyers.

Thirdly, market well and completely. Top-tier photography grabs attention. Floorplans are expensive but help buyers envision their lives in your space. Online ad campaigns targeted to the right buyers work. Throw parties for neighbors. Gather intelligence from every visitor. We do all this stuff, but not everyone does.

But I Want to Buy, Not Sell! This is Depressing!

Oh, there are great ways to win when representing a buyer, but that is another analysis piece for another day :-)

Conclusion

The assertion that housing prices are falling rest upon arguments that are either incorrect or ambiguous. The claim that Palo Alto prices are falling is true, but misses an important subtlety: less desirable, older, smaller houses are the apparent cause of the decline. The claim that houses are all cutting prices and therefore on the back foot ignores the truth that list prices are just a marketing tactic and, while seller expectations are slow to adjust to the new reality, it is less clear that the same house is worth less now than a year ago. And the arguments that the environment is worsening are all speculative or out-of-date or ambiguous in their impact.

It’s going to be fine.