Banks are Adjusting, and It's OK

I'd like to take a minute to translate (in my words) what is happening with lenders right now. The long and the short of it is that there is a normal economic adjustment being made, which was predictable, and should lead to a more stable market for the near future's expectations. It is a great time to sell in our area. It is a great time to buy. Let me explain why. Please read on.

If you were someone who knew that you could lend someone $10.00 and get back $18.25 would you lend them the money? What if you did it 100 times? You would have lent out $1,000.00 and received $1,825.00 in return, right? That's a profit of $825.00 on a $1,000.00 investment.

Well, what if seven of the 100 loans did not pay you back? You would still receive $1,697.25 for putting out $1,000.00. So even if someone told you that seven out of 100 of your loans might not pay you back, would you make the loans anyway? I probably would. That's over 69% return on my money. I would especially do it if I could make money like that in a short period of time...like say 9 years. (Keep reading.)

Let's take the Los Altos homes market and do a little comparison to my above example, starting from the bottom with $10.00, and also with $750,000, which was very close to the average sale price of a home in 1997 in Los Altos ($743,358 actually).

Year Real Appreciation If were $10.00 If were $750,000
2006 2.97% $ 18.25 $ 1,368,694
2005 14.68% $ 17.73 $ 1,329,216
2004 13.71% $ 15.46 $ 1,159,066
2003 -0.64% $ 13.59 $ 1,019,317
2002 2.31% $ 13.68 $ 1,025,883
2001 -24.30% $ 13.37 $ 1,002,720
2000 34.24% $ 17.66 $ 1,324,597
1999 17.70% $ 13.56 $ 986,738
1998 11.78% $ 11.18 $ 838,350
1997 $ 10.00 $ 750,000

As you can see, $10.00 truly would become $18.25 in 9 years. $750,000 would truly become $1,398,000. The "Real Appreciation" column reflects the actual appreciation realized in Los Altos during those specific years.

Now, what if you knew that after a while, you would be getting back only $14.50 for the same $10.00 loan for which you used to get $18.25 back? Would you be willing to lose those seven out of 100? That would net you a total profit of $348.50, for which you were earning $697.25?

I'm thinking you may reconsider who those seven people are and try to weed them out of your loan making process.

That is my interpretation of what happened recently with lending. As prices were going up so consistently lately, banks loosened their loan qualification criteria so they could make more loans. They knew there was certain risk. They calculated the risk versus the return, and took the risk.

Because the market forecasts are more conservative than they have been over the past decade, banks are readjusting their qualification guidelines so they have to absorb less risk. Of course, this means they would then be able to forecast better profits.

Some of the little banks that came in as a temporary lender to capitalize on such sure profit, may not have had the experience that larger, more established banks have. Those banks are going away. Those banks are making lots of news.

It is fair to say that double digit percentage increases in price cannot be sustained over long periods of time. Five out of the last nine years in our example of Los Altos, showed growth of double digits. It is prudent that banks not expect that much longer.

Our county has sustained more like 7% per year average appreciation over the last 30 years. A 30 year sample is much safer to rely on than the shorter time period.

Remember LOCAL market information means more to us than any other news. Locally, here is a little more information to keep you in the know. These are for closed sales since August 1, 2007. "DOM" = Days on market. "% over ask" is percentage of homes listed that sold over asking price.

City Average DOM Homes sold over ask % over ask
Los Altos 25 17 out of 24 70.83%
Los Altos Hills 48 1 out of 7 14.29%
Menlo Park 34 14 out of 28 50.00%
Mountain View 20 17 out of 24 70.83%
Palo Alto 18 26 out of 36 72.22%
Portola Valley 68 0 out of 3 0.00%
Sunnyvale 32 38 out of 87 43.68%

As long as we continue to average around 7% appreciation in our area (which is fair to expect) while adding to it the tax benefits of homeownership, it is still a great place and time to own real estate.