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Housing is indeed heading higher

October 18, 2012: 5:00 AM ET

As Fortune predicted last year, a robust recovery in home prices is under way.

FORTUNE -- In spring 2011 this writer penned a controversial cover story titled "The Return of Real Estate" that predicted a strong rebound in housing. At the time, prices and sales were still tumbling, and the prevailing view among economists and pundits was that the slide would drag on and on. But Fortune's contrarian forecast proved right. By October of last year, new- and existing-home sales and housing starts had begun an upswing that's been gathering strength ever since -- and prices joined the march in early 2012. The data conclusively confirm what Fortune predicted back then: "Housing is back."

And yet skepticism about the strength of the recovery persists in some quarters. So we decided to revisit the metrics that led to our bullish conclusion on home prices. In the 2011 story, Fortune argued that a severe shortage of new homes was providing the foundation for a resurgence in both sales and prices. Much of our data was provided by Mike Castleman, chief of Metrostudy, whose inspectors drive by 5 million lots every three months to gauge how many homes feature a for sale sign and how many are actually being sold. We asked Castleman where the recovery stands now and how it's likely to play out.

MORE: 3 reliefs and 3 worries for housing

Castleman continues to see incredibly tight inventories. In the 65% of the country his company covers -- including Florida, California, and Arizona -- his late July survey showed just 29,400 new homes that are vacant and for sale. That number is less than 30% of the 100,000 that Castleman considers "normal inventory." In Las Vegas just 764 new homes are on the market, vs. 4,867 at the frenzy's peak in 2006. The recovery so far has happened despite relatively weak demand.

But today's puny sales are set to strengthen. Castleman projects that the number of sales in his markets will jump from 149,000 today to 257,000 in 2015. That 257,000 is just 60% of the homes that sold in a pre-bubble market. Yet those relatively paltry sales would significantly tighten inventories and swell prices. Builders can't increase production nearly fast enough to meet even a modest rise in demand for new houses. According to Castleman, a major reason is the shortage of "ready to go" lots -- with permits and basic site work in place -- in good locations. "The lots in top locations will all be gone by April of next year," he says.

How about the glut of foreclosures that was supposed to keep prices falling? As last year's story predicted, it hasn't happened. Investors are buying distressed homes and leasing them for big returns. "We reckon that around 700,000 homes a year are being converted from owner to rental," says Gleb Nechayev, an economist with real estate firm CBRE. "That's preventing any buildup in inventory of existing homes."

So the supply side of the market is bound to remain tight. The big question is whether Americans renew their love affair with home ownership only gradually or with a burst of enthusiasm. Here's a new prediction: The latter is a lot more likely than the experts are now saying. The housing comeback continues.

This story is from the October 29, 2012 issue of Fortune.

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About This Author
Shawn Tully
Shawn Tully
Senior EDITOR-AT-LARGE, Fortune

Shawn Tully has been writing feature stories for Fortune since 1980. He's covered stories as varied as the Vatican's finances, the exile of fugitive commodities trader Marc Rich, and the disastrous merger between Guidant and Boston Scientific. He specializes in banking, federal budget and spending issues, and health care. Tully holds a B.A. in English from Princeton University, an M.B.A. from the University of Chicago, and a master's in Applied Economics from the Universite Catholique de Louvain in Belgium.

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