This post first appeared in the June edition of: Cirios Trends: Finding Real Estate Opportunities.

This month’s spotlight falls on East Palo Alto, CA, perhaps one of the Bay Area’s most interesting pockets of real estate and an excellent illustration of the effect of housing boom and bust on marginal areas. Surrounded by islands of almost inconceivable wealth, East Palo Alto (or “EPA”), for many years remained a low-price, crime-ridden enclave that more wealthy residents in the area wouldn’t dare set foot in.

Towards the peak of the boom, the forces of real estate pricing began to bring change to EPA. Entire neighborhoods were bought up, torn down and redeveloped into either commercial space or new residential housing. Gentrification began happening at an accelerated pace, during which time prices rose almost 70% in just four years. When the bust hit, the market tumbled even more quickly than it rose. Prices fell 60% in a single 12-month period. On the graph below, witness the massive supply spike that coincided with prices falling off a cliff (note also the scarcity of blue data points during this time, indicating an extremely illiquid market). Since that time prices appear to have stabilized at around year 2000 price levels and supply has returned to more normal levels.

The question, of course, is where will EPA go from here? With crime again on the rise and municipal budgets slashed by plummeting tax revenues, EPA could again be plagued by the troubles it has known for decades. But the fact remains that EPA has by far the most affordable housing on the Peninsula. Investors are finding value on these once dangerous streets, betting the disparity between EPA home prices and everywhere else will narrow in the years to come.

This post first appeared in the SPECIAL EDITION: Cirios Trends: A Decade in Flux

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Since we just spent the last ten pages laboriously scratching the surface of complex macroeconomic trends with a few over-simplified charts, we will now analyze every single US housing market by looking at sales data in two cities.

As we wrote in April 2009, “The bifurcation of the real estate market continues, as troubles in the high end are picking up the slack while low-end markets grope for a bottom.” This trend has persisted for months, and as foreclosures creep into higher end markets, we believe the trend will persist for the foreseeable future.

Below are sales transactions for the past ten years in East Palo Alto. East Palo Alto, which in 1992 had the dubious distinction of being “murder capital, USA” by tallying the highest murder-per-capita rate in the entire country, has undergone a renaissance of sorts. Sort of.

As Silicon Valley wealth swelled during the dot-com boom, so too did housing prices. One of the last bastions of affordability on the Peninsula, real estate speculators flocked to this rough town for high risk, high reward development. The town experienced a decade of gentrification on steroids, as home prices became completely unhinged with the economic prospects of the area’s residents.

This story was repeated in cities across the country, each with it’s own unique flare. Vegas condos went through the roof. Track homes in Phoenix were flipped monthly by amateur and professional real estate speculators alike. Waterfront homes in the quiet town of Cape Coral, FL approached $1 million apiece.

But now, as prices in these markets have returned to earth, buyers are wading back in, armed with government loans, tax credits and a newfound fear of the stock market. Inventory is being constricted by ongoing foreclosure moratoria and in certain markets, prices have begun to stabilize.

The arrow below points out the steep price declines from 2007-2008 on few sales transactions. The shaded circle shows buyers stepping back in and prices groping for a bottom.

(click to enlarge image)

On the other side of Highway 101, the city of Palo Alto exists in precise contradiction to its neighbor to the east. Quiet streets, large lots and excellent schools make Palo Alto one of the most desirable places to raise a family in the entire country. Home prices, as one would expect, are very, very high.

Palo Alto residents have had decades of prosperity to accumulate wealth, and a few bad months in the stock market or the loss of a job doesn’t necessarily spell financial ruin. Fewer mortgage defaults, less dependence on credit cards and a general affluence meant that the bubble popped here later, and with less vigor. In other words, the “Price Discovery” (ie, a precipitous drop in prices resulting from a void of buyers, only to be stabilized as buyers step back into the market looking for bargains) that has occurred in East Palo Alto is yet to come to well-to-do areas like Palo Alto.

As can be seen from the green shaded oval below, Palo Alto experienced a mini-bubble on the tail end of the dot-com boom. Prices have now fallen to around where they were back in 2004, but only just below the maniacal glory days of Pets.com and WebVan. And, as foreclosures infiltrate these luxury markets, forced sales are becoming more common. This is beginning to drive down prices, as can be seen in the recent dip that picked up steam earlier in the year.

Luxury markets around the country have seen a similar trend in home prices: A later peak and less dramatic fall, but prices that are yet to be supported by opportunistic investors. But all is not bleak in other Palo Altos around the country.

These high-end markets have benefitted from the strong stock market of the past 9 months. If the economy can avoid another tumble and markets can remain resilient as the government gradually withdraws its stimulus, high end markets may find support sooner than many skeptics think.

(click to enlarge image)

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