According to many, many articles including detailed analysis of foreclosure trends in California, we are currently seeing the tip of the foreclosure iceberg in high-end areas like Los Altos and Los Altos Hills. The problem lies in what are called "Option ARM" loans. These loans allowed relatively poor people (working professionals) to cram into multimillion dollar homes that were previously reserved for the very rich.
When these loans come due after five years, they don't merely reset to a higher interest rate, they "recast" to a new loan format. Option ARMs were loans that allowed buyers the "option" of paying a normal loan payment, an interest-only payment or a negative amortization payment. Their ability to pay was based on the minimum payment, and with the utter certainty (har har) of a couple's home price going up. People jumped in head first being able to afford ONLY the minimum payment.
When they recast, homeowners are left to get a new loan for their home. Now that there is no expectation of wild returns, banks are forced to only offer "normal" 30-year fixed mortgages to these people--if they are lucky. At minimum these payments are probably twice what the old ones were. These loans were typically given out to people "on the edge" and could barely afford the negative amortization payment.
Again, you have to remember the Bubble days: "cram into as much house as you can so you can maximize your returns!". The more you stretched, it was thought, the more money you would make. So people stretched. Many of those people ended up in Los Altos and Los Altos Hills.
Today Los Altos and Hills both have an enormous "shadow inventory" of people who want to sell but are waiting until the market "recovers" back to the Bubble times.
However deluded they may be, they are often in the position of waiting until hell freezes over to sell their house. This has frozen the market here and made comps very few and far between--so few that you can't trust them as an adequate indicator of the true market.
Foreclosures change all of that. They force the market to get liquid (people or banks must sell immediately), which in turn forces prices to get down to a true market-driven level.
What is that level?
The answer to that can be found in the "price-to-rent ratio" (Google it). In short, a $1 million home should rent for about $5000 per month. It doesn't matter how "nice" or "desirable" or whatever our area is (and our area is all of those things) rent is rent is rent. It reflects what the market will pay to occupy the home.
Right now $5000/month rents you a $2 million or more home in Los Altos if you believe the prices on MLS (which you can't).
So in short, don't buy a house in Los Altos (or anywhere for that matter) unless you could actually make money (or break even) by renting it out. Otherwise you are essentially betting on prices going way UP in the future, which is risky at best.
Also, pay attention to rent prices here too. They have dropped and if unemployment continues and there are more layoffs then rents will be depressed further, which means you need to re-compute for that.
Can you expect appreciation here in the long run?
Demographics and long-term trends are stacked against long-term appreciation. The Baby Boomers are moving away from their big expensive houses next to work (that's us) to smaller homes in the middle of nowhere. Immigration in California is down based on negative sentiment, fewer jobs here and better jobs "there". Many high-paying jobs are leaving California.
All this will have a downward drag on prices here for a long, long time.
In the early 1990s people considered Tokyo, Japan to be a very expensive place that had real estate that would never go down. Japan went through a similar Bubble to the one now deflating in the US. Tokyo prices fell to half of their all time highs and NEVER WENT UP FROM THERE AFTER 15 YEARS AND COUNTING.
This isn't your father's California where prices just keep going through the roof forever. Welcome to Tokyo, folks :-).