As Facebook goes, so goes Palo Alto real estate

June 13, 2012: 10:37 AM ET

Housing prices in Silicon Valley's tony neighborhood soared before the Facebook IPO. Now inventory is soaring.

By David A. Kaplan

FORTUNE -- You can take the pulse of the prospects of Silicon Valley by checking stock prices, revenues, profits, hiring, even press clippings of various companies. Or instead maybe you should just look at the real estate market in Palo Alto, California.

After all, this is where Mark Zuckerberg lives, where Steve Jobs used to, and where countless entrepreneurs and their financiers want to move. When the price of that megalo-mansion just keeps going up -- hey, do you think it has a gift shop? -- we all say it's boomtown in the Valley. But when the value of that modest two-bedroom bungalow actually comes down near a meager $1 million, we say the end of the bubble may be nigh.

Not quite so, as many companies in the Valley, new and old, continue to soar. But the shortcomings of one iconic company, Facebook (FB), now seem to be taking their toll in Palo Alto. Before Facebook's May 18 IPO, when we last paid a visit to the town's oak-lined streets -- where even the trees have fabulous price values associated with them -- the housing market was going especially bonkers.

That's because so many sellers, expecting a bountiful IPO along the lines of the Google (GOOG) bonanza in 2004, kept their homes off the market. For the first quarter of this year, for example, the median price of a single-family Palo Alto home went up 11%, while inventory declined 57%.

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All that changed when the Facebook IPO flopped. Since the stock peaked at $45 on the day it opened, it has gone as low as $25.52, a decline of 43% and 33% below its IPO price of $38. (It closed Tuesday at $27.40.) The result in Palo Alto has been a flood of houses going on the market. It's a small set of data, but it tells a story of vastly changed seller psychology. Right now, there are 104 houses on the market -- more than double the number over the winter, according to numbers culled from the Multiple Listing Service.  Even compared to last June, inventory is up 44%.

In nearby Menlo Park, where Facebook's new headquarters are located, the trend is less pronounced. There are 103 houses currently on the market, up about 80% over the winter and nearly 20% more than a year ago.

"Facebook gave me a gift in showing my sellers there's no sure thing and don't-look-a-gift-horse-in-the-mouth," says Michael Dreyfus, a prominent residential real estate broker based in Palo Alto. "The "make-me-move" prices -- where a seller says, 'I know my house is worth $5 million but if somebody pays me $10 million I'll take it,' are over due to the Facebook bomb."

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Dreyfus says sellers are realizing, as they always have in past run-ups, that things may get worse before they get better.  "I wouldn't call it a panic," he says, "but it's a good dose of reality."

One of his clients is a venture capitalist in his early 40s, looking to buy in the mid-range for Palo Alto homes: $3 million to $4 million. The VC had been outbid on several properties during the pre-Facebook frenzy, when asking prices could be a mere suggestion -- on the low end. The VC hoped for a lackluster Facebook IPO. He got it. Last week he excitedly emailed Dreyfus as well about the recent dearth in new high-tech IPOs. Both, the VC wrote, "may help us."

When a VC is cheering on the return of apparent rationality, it's pretty clear that things have changed.

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