The local housing market is cooling down from its record-high prices of the first quarter due to a drastic shift in the economy. Tumbling tech stocks, interest-rate hikes and inflation are among the underlying fundamentals of the housing market that are deteriorating at a speed faster than many of us have experienced.

The median price of a single-family home in Palo Alto dropped to $3.55 million in the second quarter of this year, representing a 13% decline from a record-breaking $4.1 million in the first quarter.

The average 30-year fixed mortgage rate has almost doubled in the past six months, approaching 6% in mid-June — a rate that we haven’t seen since the early 1980s. This has had a direct impact on buyers. Many can no longer afford the entry-level price point in the Midpeninsula market. Many of the open houses for entry-level homes priced below $4 million in Palo Alto had almost no visitors in recent weeks.

Absorption ratio, the percentage of active listings that go into a pending sale during the same period, is a relatively real-time indication of the hotness of the market. In the first quarter, the ratio was 73% for single-family homes in Palo Alto. The ratio went down to 43% in May and 23% in June. It now takes more than two weeks on average to sell a property, compared with eight days in the first quarter of this year. Many of the entry-level homes are not selling at all.

For the first half of this year, 289 single-family homes in Palo Alto went on the Multiple Listing System, a 14% decline compared to the first half of 2021. Of these homes, only 209 were sold or pending, representing a 26% decline year over year.

Neighboring cities show a more mixed picture. Both Los Altos and Menlo Park had more homes at higher prices than Palo Alto. Those bigger, newer and move-in-ready homes are in high demand from buyers. In Los Altos, it’s very common for a newer home listed above $5 million to receive multiple offers and sell for $500,000 over asking price. For Los Altos, the median sales price remained at just above $4.3 million during both the first and second quarter. Nonetheless, the absorption ratio declined from 68% in the first quarter to 33% in June.

Palo Alto has been lagging in terms of price appreciation, compared with Los Altos and Menlo Park for more than three years. The main reason is the lack of the “right” product, as most of the home supplies in Palo Alto tend to be small and old.

From a long-term cyclical perspective, when home prices dropped during the “tech bubble burst” in 2000 and again in the “financial bubble burst” in 2008, it took two to three years for prices to bottom, followed by a steady recovery over the next five to six years. As the world has become unsettling, the median home price in Palo Alto has gone up and down multiple times since the current cycle started in 2016. It still has been on a general upward trend as the world’s wealth creation remains in tech.

While the pandemic accelerated the wealth concentration in Silicon Valley and fueled a rapid increase in home prices, those dynamics are now changing as local big tech firms have turned more cautious about the future’s outlook.

On an annual basis, the biggest drop in the median sale price in Palo Alto was 11% in 2001 when there were 1,150 new listings. The supply has come down to around 550 homes every year since then, except last year when we had the pent-up supply from the pandemic.

Will 2022 end up with a double-digit price decline from last year? Whether buyers will return to action in the fall and how sellers react to the slowdown will be the key drivers. The rising mortgage rate will force the potential sellers to think twice about putting their properties on the market, as they do not only give up the low property tax base but also the low-interest mortgage. This may dry up inventory further that could support home prices.

On the positive side, when both housing prices and inflation stabilize, investors and developers could finally get back to the market to resume building. Hopefully, it will bring more new homes to the market in two to three years, and solve the mismatch of supply and demand, especially in the prime neighborhoods of Palo Alto.