Once in a while, I come across a really useful real estate article to share with my readers.  This one from the Wall Street Journal is surprisingly simple and yet powerful.  It describes research results which confirms our general intuition about distressed properties, like foreclosure short sales and bank owned, weighing down overall real estate prices.  As the percentage of distressed properties on the market increases, it drives down market prices by a similar percentage.

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This relationship can be explained by simple market pricing mechanism.  With each additional distressed property, there's more competition for purchasing dollars with existing distressed and non-distressed properties.  Since distressed sellers are less price sensitive for a large variety of reasons (described in my prior blogs), the negotiated prices will fall until buyers feel they are getting a compelling value.

Thus, with a high proportion of distressed properties, more distressed transactions will close, which leads to lower median prices for all other properties.  This forces the non-distressed sellers to either lower prices to compete or back out of the market.  The vicious cycle continues so that eventually, fewer non-distressed sellers are in the market than normal and the distressed properties come to

dominate on a proportional basis.  As the high quality non-distressed properties are not being put on market, the median price is driven down further.

That's what we've all been witnessing here in the Bay Area and particularly in San Jose.  While the volume of distressed properties has dropped from earlier in the year when banks flooded the market with their real estate holdings, the percentage of distressed properties has remained high, reaching above 50% in some neighborhoods.

So, what does this mean going forward for the local market conditions?

Since the pipeline of distressed properties looks solidly in place with little improvement in the regional employment situation, the proportion of distressed properties appear poised to continue climbing through the rest of the year.  This trend reflects more of a drop in non-distressed sales than a rise in distressed properties.  So, while the chief economists of the NAR and CAR offer vacuous forecasts based on guesses about household formation and employment, we take a more ground-level approach and track the actual property inventory figures on a monthly basis to provide our guidance to clients.