As a whole, the Bay Area housing market has followed the pattern of the rest of California: sales volumes have dropped 33% from their peak in July 2004, and with median sales prices flat to slightly falling in 2006. The East Bay’s slowdown has looked similar on the sales side, with sales in Alameda County down 39% from their peaks, and sales in Contra Costa down 32%. However, the slowdown on the price side has been much more severe in the East Bay in 2006: through August, median sales prices have fallen 3.8% in Alameda County and 3.6% in Contra Costa County. Figure 7: Bay Area Total Home Sales (area) and Median Sales Price (line) (SA)
Figure 8: Alameda County Total Home Sales (area) and Median Sales Price (line) (SA)
Figure 9: Contra Costa County Total Home Sales (area) and Median Sales Price (line) (SA)
At first glance, these price declines present a bit of a puzzle: historically, significant declines in nominal home prices normally occur only during recessions. The local experience during the last recession supports this view: while the rest of California’s housing markets barely noticed the recession, the severity of job loss in the Bay Area economy led to moderate home price declines in 2001. So with the Bay Area economy as strong as it has been in five years, why are we seeing the median sales price fall in the East Bay?
There are two answers to this apparent contradiction. The first hinges on the role of new homes in East Bay housing markets. As we will discuss in the California Outlook section, the counties where new homes make up a bigger share of total sales have seen slower price growth in 2006. The East Bay counties fall in the middle of the pack: in 2005, new homes represented 12% of total sales in Alameda County, and 17% in Contra Costa County – far below the 25%-40% in the Sacramento area, but much higher than the 4% in San Mateo County and 10% in Santa Clara County. The share of sales that are new homes matters because builders historically have been much more willing to trade a lower price for a quick sale. Since builders are unwilling to hold unoccupied inventory and do not have the option of renting the houses (for fear of turning a new house into a used house), when demand slackens they will respond with significant price cuts. Owner/sellers, on the other hand, have been unwilling to accept lower prices in the past except when forced by job loss. Instead, homes are listed at prices that buyers are unwilling to pay, and the number of listings rises as the number of transactions falls – just as we’re seeing in 2006. Thus, with housing market cooling in the relatively healthy Bay Area economy of 2006, we should expect to see the price of new homes falling, but the price of resale homes basically flat. In markets where new homes make up a bigger share of total sales, the rapidly falling price of new homes will have a bigger effect on the median sales price, generating the relationship between share of new home sales and price growth that we’ve seen in 2006. Fig.10:
Fig.11:
The role of new homes in the East Bay housing market is certainly part of the reason that median sales prices have fallen in 2006, but it’s only part of the story – after all, Contra Costa County has a higher ratio of new homes to total sales than Alameda County, but has experienced less of a fall in median sales prices so far. A brief look at the median price of new homes sold in the two counties is enough to see why: the median price of a new home purchased in Contra Costa county has fallen just over $100,000 since January 2006, but has fallen close to $230,000 from March to July in Alameda County! These new home prices are obviously the major source of the weakness in the East Bay’s overall home price statistics.
Yet these $100,000 swings in the median sales price of new homes in Alameda County are pretty suspicious, and point to the second explanation for why home prices in the East Bay have looked so weak – it is partially a statistical mirage. The median sales price statistics from Dataquick that we’ve looked at so far are just that: the middle of the price range of all homes sold during that month. So if one month sees a lot of new condo sales and the next month sees a new luxury development start selling, the median sales price can fluctuate wildly, driven by nothing other than the changing mix of homes sold. One look at volatility in the median sales price of new homes in Alameda County (which includes both detached homes and condos) suggests that these mix effects are a large part of what we’ve seen so far in 2006, and can help to explain why Alameda County looks worse off than Contra Costa even though new homes are a smaller share of total sales.
More evidence of the importance of these mix effects in the East Bay housing market comes from comparing the declines in Dataquick’s median sales price to Office of Housing Enterprise Oversight’s Home Price Index (HPI) for the East Bay. In the first two quarters of 2006, the median sales price in the East Bay dropped 1.5%, but the HPI rose 2.3%. This is significant because the HPI controls for mix effects by estimating appreciation based on repeat transactions on the same property. Thus, the HPI is an attempt to answer the question we really care about: how has the price of the same house changed in the last two quarters? According to the HPI, its price is rising at a slower rate than in previous years – but it’s still rising. There are several areas in California where median home price is dropping while the HPI is still rising, indicating that mix effects are partially to blame for the declines in home prices we’ve seen in 2006. In fact, Sacramento is the only metropolitan statistical area in California to see a decline in the HPI so far.
So the bottom line on East Bay home prices in 2006 has been a double whammy: prices have been weaker than other areas because of the relatively high share of total sales that are new homes, but a large part of this weakness has come from a decline in the average quality of homes being sold recently. Controlling for these mix effects, the HPI suggests that home prices in the East Bay are still rising in 2006 – barely. But while these measurement issues make it hard to decide whether prices are flat or falling, one thing is clear: the East Bay’s housing boom is long gone.
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