Will Palo Alto Home Prices Crash?

July 18, 2022

 Executive Summary

Probably Not!

• Palo Alto real estate has soared since 1998: median dollars per square foot rose from 389 to 2,186, even accounting for recessions and bear markets.

• Booms have historically run for 6.1 years and see property prices rise by 77%.  Busts are shorter and milder: 1.4 years and a 15% hit to property values.

• There is no obvious reason to think that anyone can reliably time the market. 

• It is not obvious that there will be a downturn.

The Question

It’s been a tough decade for would-be Palo Alto homebuyers who have been waiting for “the crash”.  Prices have been relentlessly rising year after year.  But perhaps now the tide is turning. Stock markets are firmly in bear territory led by declines in local titans Meta, Alphabet, and Apple.  The Federal Reserve is grimly determined to quell inflation even if it means driving the economy into the ditch.  Perhaps the longstanding seller’s market for housing will turn into an long overdue buyer’s market.

Such Buyers might be tempted to wait, hoping to buy in after “the crash that is sure to come”.  But as this analysis will suggest, they may be waiting a long time, and for little upside.

To believe that waiting is the correct course of action, a buyer needs to believe some combination of the following: that housing downturns last a long time, that prices will fall materially, that markets can successfully be timed, and that the current macroeconomic and world events will indeed force a downturn.  All these arguments are suspect.

A Historical Approach

The housing market of 2022 is in fact a lot less volatile than the stock market of 1929.  Rather than fire sale desperation on the part of sellers, a Palo Altan homeowner in a downturn is in a much more stable position.

“Hey wait…  this looks like a smooth-ish upward trajectory,” you say.

Indeed it is, astute reader.  What we see above is the median dollars per square foot of all the on-market transactions in Palo Alto since the start of 1998.  Median is preferred over average, because there can be some really affluent homes that distort averages.  Dollars per square foot is preferred over sales price because it equalizes for the trend towards bigger homes.

“How tightly are the base data packed around the median?”, you ask, not wanting to be fooled by lies, damned lies, or statistics.

The curve above is a second degree polynomial curve; it tells the main story.  But see that bulge in 2001 of high-end homes transacting after the Dot Com bust?  Or the downward bulge in the Great Recession?  Or the progression from more clustered before the Great Recession to more scattered afterwards?  These are interesting sidebar stories, but don’t change the main narrative.

“But the Dot Com Crash and the Great Recession destroyed housing values.  I remember those recessions vividly!”

Yep, they really happened.  Here are those periods hilighted, plus the COVID-19 recession also (recall we were briefly in dire straits before everything boomed?):

Recessions are real, and they *are* associated with material declines in housing value.

The periods colored in red above are defined by the National Bureau of Economic Research (NBER).  Their definition of a recession is “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”  The rule of thumb is that a recession is when there are two consecutive quarters of negative GDP growth. The reality is more nuanced, but that is roughly it.

It's not hard to notice that the green periods are longer and define the direction of the market much more than do the red periods. Recessions are modest downward adjustments to an asset class that is unambiguously appreciating.

“Well we are heavily equity-compensated in Silicon Valley.  Maybe recessions are not the right metric; surely stock market crashes will hurt Palo Alto housing”

You are so correct, dear reader! Bear markets are when equities drop 20% or more.  This can apply to an individual stock, a sector, or and index.  We use the Dow Jones Industrial Average (DJIA) in this analysis.  In the past year until July 5, 2022, it has fallen 17%.  But this is understating how it feels here; our local economy is much more influenced by tech giants like Apple (down 22%), Alphabet (aka Google, down 26%), and Meta (aka Facebook, down 57%).  It is indisputable that Silicon Valley’s paper wealth is taking a material hit. 

As realtors, we can assure you that the stock market nosedive (combined with increased interest rates) has caused many buyers to pause their searches.  Yet, based on historical data, it is not assured that this will translate into steep declines in home prices.

It’s a nice argument, though it still gets applied to the same upward chart of median home prices, so we already know the results.  If we represent bear markets in yellow, we can see they are also associated with housing downturns:

Despite the fact that bear markets in equities cause downturns in Palo Alto property prices, they are short sawtooths down on a curve that rises generally up and to the right.

So whichever way one chooses to define a downturn: based on Recessions or Bear Markets… and the two are typically correlated… a downturn in Palo Alto housing is not that bad.  But how long have downturns been?  And how deep are they?

How Long Do Downturns Last?

If Palo Alto property market downturns are short, then maybe everyone can just hold their breath and ignore them.  How long have previous downturns lasted?

If we use recessions as our markers of downturns, we see:

The Dot Com Recession started in March 2001 and lasted 0.7 years.  It took Palo Alto housing a full 3.9 years to recover from that wreckage.  The Great Recession was almost the same at 4.3 years to regain the pre-recession housing price.  COVID-19 caused a drop in property values, but at only 0.8 years to regain the previous peak, it was very short-lived.

If we use bear markets instead:

We see that stock market carnage causes slightly more damage to Palo Alto home prices:  with slightly different dates to define the causal event and therefore the peaks and troughs, we see that it took Palo Alto property 5.1 years to recover from the Dot Com crash, 4.4 for the Great Recession meltdown, and 0.8 years due to COVID.

Are these times “long”?  It’s not really clear.  But they are certainly small compared to the Great Depression – once stocks collapsed in 1929, they took over 25 years to recover!  Most Americans move every seven years, so while the idea of being underwater on your investment for 5 years may be harrowing, you’d statistically come out with a gain, if history is any guide.

Conclusion: downturns have ranged from 0.2-2.8 years for Palo Alto property values to start recovering, and a total of 1-5 years to fully recover.

How Deep are Downturns?

Even if the duration is not terribly long, a deep downturn can be crippling if one is forced to sell at the very bottom due to divorce or other unexpected reason.  How deep are Palo Alto housing downturns?

The Dot Com recession cut the deepest in terms of local housing:  in a mere 0.7 years, dollars per square foot fell by 33%!  The Great Recession was more muted, and COVID was just a blip.  Falling stock markets showed a similar decline:

Are these scale of these declines bad?  They certainly are not enjoyable, but as we see above, the drop in the stock market is notably larger (-36% average drop in the DJIA versus an average 15% drop in housing $/ft2).  But a 15% drop on your biggest investment would be awful *if* you suddenly had to move in that 0.8-5.1 years until the full recovery.

 Conclusion: downturns have resulted in a 5-33% drop in house values, which happened 0.2-2.8 years after the start of the downturn.  The median of these 6 figures is an 18% drop. 

Downturns Vs. Upturns

While the housing market can indeed go down, it more typically goes up:

Looking in this case at bear markets in red text, and the intervening boom years in green, a pattern is quickly evident:  the booms are longer and of greater magnitude than the busts. In fact, if we average the three booms and three busts (which may be a statistically dubious thing to do, and presumes the current boom is over), we see that an average boom lasts 6.1 years versus only 1.4 for a downturn.  And booms are associated with a 77% rise in property value, versus a drop of 15% for a downturn.

Conclusion: Booms on average run for 6.1 years and see property prices rise by 77%.  Busts are shorter and milder: 1.4 years on average and a 15% hit to property values.

Timing the Market

So Palo Alto downturns are relatively short-lived and mild, especially compared to Palo Alto’s default boom state.  Typical homeowners might sail through such downturns even if they have the misfortune of buying in at the worst possible time. 

“But it’s still better to time the market if we can, right?”, you say.

The problem is…  no one knows how to reliably do this.  Take the recent pandemic for example. At the start of the coronavirus lockdowns, real estate was initially deemed a non-essential service.  A realtor showing a house to a prospective buyer was deemed a needlessly risky vector of disease.  Sellers did not want contagious people walking through their property.  Essential cogs in the machinery of buying a house, like title companies, appraisers, and bank lenders, just stopped coming to work.  The legal risk of buying or selling a house was unclear—if someone visited your listing and caught coronavirus and accused you of giving it to them and they died… what would happen?  The stock market was falling, the economy in cardiac arrest, and no one knew when it would end.

No one was really thinking that every family would need 2 more bedrooms per house.  No one foresaw how much Zoom would be in our lives, or how we’d need our home gym and home playground and home everything.  Palo Alto real estate went up 29% since the end of the COVID-19 bear market (as of the time of this analysis), but at the best time to buy, we were all too busy wiping our mail with disinfectant to realize it.

It’s really hard to time the market.  If it were easy, the richest people in Palo Alto would be real estate speculators, not tech luminaries.

“But only a fool would buy just before a crash.  I’ll only buy after the market finds its bottom; it’ll be obvious when it happens” you say.

People moving into Palo Alto tend to be really smart people doing something right in life.  If smart people can time the market, we should expect no transactions just before and in the first half of a downturn, and lots of transactions in the upswing.  Does that data show this?

In this monthly view of transactions, we can see a distinct annual seasonality (lowest months in January, highest months in spring and fall).  Notice that in the Great Recession, the same seasonality was observed, even though the end was not near!  It sort of seems like transactions declined during the Great Recession, but the seasonality can muddle our eyes. In an annual view:

Transactions did obviously fall during the Great Recession, but again it is not as dramatic as the “Great Depression stock price curve” that may be in buyers’ minds.

Conclusion:  it is hard to time the market.

Reasons To Think That Palo Alto Housing Won’t Stumble in a Downturn

“OK, so downturns aren’t that big or deep, and trying to time the market is just trying to be lucky.  But when we’re obviously right at a recession, I should wait, right?”

It’s actually not obvious at all that there will be a housing downturn this time.  What are the reasons for optimism?

1. Housing is Abruptly More Valued

COVID caused people everywhere to want more home.  Extra zoom rooms and home offices and home gyms made residential housing, as an asset class, discontinuously more valuable than before.  Will people abruptly go back to the “sharing economy” and movie theatres and sports bars and health clubs, reducing the primacy of “home” in our lives?  It’s not clear, but it does not seem to be happening much yet.

2. Housing Was Underbuilt Even Before COVID

As a consequence of the Great Recession, many young people delayed starting families and buying a starter house.  The cumulative amount of pent-up household formation continues to this day.  Goldman Sachs estimates 2.4 million 25-44 year olds who would typically be starting their own household, but are currently not.

3. Low Inventory

Sellers are under pressure too: their nest egg to buy a new place took a hit just like the buyer’s brokerage accounts did.  To cash out of Silicon Valley to greener pastures means giving up a low property tax basis (if you are leaving California, otherwise Prop-19 has really changed matters), and 3% mortgage would be replaced with a 5+% one somewhere else.  Faced with this, more sellers are choosing to stay around a bit longer.  This means less inventory on the market, which pushes prices up.

4. Palo Alto Sellers Often Don’t Need to Sell

In a down market, many people who need to sell would have to absorb the pain.  Not necessarily so in affluent Palo Alto.  94301 is the 12th most expensive Zip Code in the country.  Many sellers here have significant financial cushion, so can just refuse to sell. 

One reason economists are reluctant to declare that we are in recession is that household excess cash is very high, and lending standards have tightened significantly since the Great Recession.  Homeowners are in a much stronger position than they were in 2007.

5. Silicon Valley’s Economy is in Overdrive

Employment rebounded strongly post-pandemic, with 78,670 new jobs between mid-2020 and mid-2021, causing total employment to rise 5.1%. New jobs were strongly concentrated in tech, while all other sectors remain below pre-pandemic levels.   Zoom and remote working take some of the pressure off, but not enough to rival how our local “industry champions” are increasingly “eating the world.” Venture capital funding reached an all-time high of $95 billion invested in 2021.  Commercial space is expanding at an unprecedented pace (21.5 million square feet of commercial space gaining planning approval).  There were more local IPOs (32) than any other year since 2000. (Many of the stats here are thanks to the excellent Silicon Valley Index 2022)

Conclusion: It is not obvious that there will be a downturn, or if there is, that Palo Alto’s home prices will be impacted, and if they are, by very much.

Summary

The perception that Palo Alto housing prices are due for a crash seems to be wishful thinking on the part of would-be buyers.  Downturns are not that long or deep, are overwhelmed by the scale of the upswings,  and there are good reasons to think that Silicon Valley housing is a sector with a lot of growth left in it.  Buyers need to be careful that their time horizon is long enough to weather a downturn, but this should not deter a buyer from participating in the tremendous long-term appreciation of Palo Alto housing.

About the Authors/Datamancers

The Young Platinum Group (aka Gloria and John) specializes in Palo Alto, Atherton, and surrounding areas.  We work with buyers, sellers, and builders to enhance exceptional lives in the finest homes in the heart of Silicon Valley. Would you like this sort of data on your side in your next real estate transaction? Or a complementary analysis of what your home is worth in the current and ever-evolving market? Contact us to start. This sort of original analytical work, customized on your behalf, with our fabled customer service, can be deployed for your needs to make your next move a smooth and happy one.  We proudly affiliate with Golden Gate Sotheby’s International Realty for our realty activities, and the Peninsula’s finest builders, architects, and designers for our development projects.