Renting has issues too. Generally speaking you'll be stuck renting a smaller, older house that no one wants to own as a primary residence, or living in a comparatively small apartment. Nice rentals are available, but be prepared to move every year when your lease is up and the owner decides to sell. Plus rents, already under some inflation pressure before the bust, are being driven up by the recently-foreclosed-upon and, perversely, because the "herd" now thinks that renting is the smart play.

A lot of buyers have been on the sidelines since the run-up in prices began, kicking themselves for being too cautions in the wake of the dot-bomb implosion. They've been hoping for a big downturn in bay area real estate. Many of them have plenty of cash from stock gains over the past few years. Their savings are paying 5% meaning they're slowly losing purchasing power after paying tax on the interest.

Government action is possible. The most obvious move would be a Fed rate cut, the consequences for the dollar be damned. The next-most-obvious would be a hike in the conforming loan limit. Neither move would be surprising in the next few months of the crisis. I won't even go into the possibility of a bailout of the underwater borrowers and bankrupt lenders whose stupidity and avarice brought this crisis upon us in the first place.

Like it or not there is a shortage of homes in desirable locations because of the geography. The recent trend in McMansion construction in outlying areas flies in the face of some energy, environmental, and infrastructural realities that are overdue for attention. Who's going to want to commute an hour a day in grid-locked freeways that simply can't be made wider, especially when gas is $5/gallon or higher? Who's going to want to pay PG&E to run a 4000sf McMansion they really don't need?

The above factors may not stop the slide but may cushion it. You may not see the steep price drops warranted by the fundamentals, but rather a long period of deflation before the long-term uptrend resumes.

I would say prices in Bay Area is just insane. The majority of buyers are from Asia or Mexico. They have not seen the previous cycles of real estate and they over-streched themselves finacially just to have a sweet-home dream. In reality, affordability always win in long term. That's why I believe the price has to come down here in Bay area.

Hari, I agree. We need a tech recession to bring things back to normal. Hubby in Cisco wife in Sun generation has pretty much skewed the whole Bay Area economics. I do not think the families can keep earnings quarter million a year for long - the job market can take a U turn any day just like it did in 1999/2000.

Well, until it's a buyers market, it just doesn't make any financial sense to buy. I'd rather dump $500,000 into a strip mall in Chicago that earns me $10,000 a month in passive income than buy a shoebox of a house here. It's without doubt a mania here. Even if home prices go up here, it still doesn't make sense to buy here as an investment.

Tightening of credit, higher mortgage rates (especially the jumbo rates which is needed anything over $400,000, @7.5%+ now) will drive the prices down. HUGE ARMS reseting now. Right now, it's quiet before the storm.

Prices in Silly Valley are still ridiculous - particularly when contrasted with the rest of the country. Inventory however is finally beginning to jump up. Particularly in 'lesser' but still desirable areas such as Fremont and San Jose. Once this realization strikes it'll be, I suspect, off to the races (on the downside). People here want to preserve their wealth as much as people anywhere.

I am an immigrant(from India). I wish the prices would go to a more reasonable level 4.5X that of 75th percentile pay in the valley, with an appreciation of 4-5% - about 600k single family . Well, its just a wish of mine. I see so many of my friends buying based on the simple need to settle and also due to the cultural bonding here. I see perennial demand from immigrants who are tightly bound to their respective groups and behave nearly in unison when it comes to buying decisions.

Also, please note that most are double income families with strong salaries making the 4-5x multiple over pay into a non-issue.

In short, I feel nothing short of a tech-recession will bring the prices down.

As soon as enough people realize the huge amount of money they could lose by buying a home in Silicon Valley, there will be a reactive change.

If I bought a house in Houston (where I was 2 years ago) and subsequently lost 20%, I'd be down some $40,000 or roughly four months salary.

If I bought a house here in Mountain View now (they same house would be roughly $1.25M) and it dropped 20%, I'd have lost $250,000 or roughly 2 years salary.

As you can see from the stock market: as soon as fear kicks in about how much you could lose, and the realization that rent costs half to one third of buying - without the downside risks - there could be a panic.

Increased leverage, shoddy broker and financier practices, and exuberant speculation are going to have its toll. Even my 4th grader can see this coming.

I know people who are paying ungodly amounts of money to make their mortgage payments in Silicon Valley, often for really small, older homes. (e.g. 5K/month, sometimes even more)

I'd say after October, when a great many loans reset, there will be a huge increase of supply in the market. You can see where this is going.

Great observation, Kris - The mid-peninsula has indeed been a reasonably strong market this summer. We designed the MAI to be an at-a-glance view to answer "how's the market?" and I think it does a good job here.

Unfortunately Rick, the nuanced variables of the real estate markets don't necessarily translate the MAI directly into bankable price implications. You might have a buyers market and stable prices or maybe they're falling. Though you can see that the super hot markets of 2005 obviously correlate with rising prices, it's mostly just a nice broad measure. I like using the MAI in the price quartiles (Kris writes about the quartiles in other posts) to see how demand trends different at different price points in the market.

incidentally, the big vertical drop in November of 2006 is a methodology change on our part. The bigger cities were adjusted into a tighter range, though all the trends and basic implications remain the same.

My guess is that this trend will start with days-on-market increasing between now and September, as sellers continue to price houses at boom levels. Then three months later, sellers will begin to lower prices, as the reality of the new market sinks in. I imagine the steepness of the drop will depend on whether the Feds drop interest rates.

The last option is the one buyers want.

I guess the big question then is "So what happens to prices in a Buyer's Market with a MAI under 30? Do prices stay steady (no growth) but days on market increases? Do prices fall a few percent? Or do they fall 20 percent or even more? Seems like anything but the last one is just fine for the market in those cities.